A few years ago, I knew the real estate market was topping when a cleaning lady, working for cash at $15 per hour, was able to buy a renovated Leaside home for $636,200 with a 5% down payment. With a forty year am her mortgage was larger than the purchase price.
David Chilton says his epiphany was when travelling in Naples, Florida around the same time, and being blown away by the crazy hyped real estate market there.
"I was absolutely shocked. Everyone was buying real estate with nothing down. A dentist bought five condos one weekend. It was obviously a bubble and I came back and sold my American stocks."
It was the Fall of 2007. I had developed a niche helping self employed individuals qualify for high ratio mortgages. Truth is, it had never been easier. At that point in time, one of the Big 5 chartered banks in Canada had the following requirements:
• Demonstrate you have been self employed for more than two years
• Prove you do not owe any income taxes to Revenue Canada
• Your personal credit score should be higher than 680
Maybe I am simplifying a bit.
To ensure self employed people had sufficient income to qualify for their mortgage, the lender simply asked them to write a letter stating how much gross income they made in the prior year and how much they expect to make in the current year. This is called a "stated income approach".
In other words, whatever income you need to qualify for a mortgage - just tell us you make that and we will be ok. It was actually easier to qualify for a mortgage in those days as a self employed - rather than a salaried individual with a guaranteed stable income. Was this madness or what?
To cover all the associated monthly expenses and qualify by way of debt service ratios, this lady had to declare an annual income of $152,000! (Don't forget, she was a cleaning lady)
This lady had a credit score of 696 - what I would call ok but nothing special. Her net income for the previous year was less than $2000. Yes you heard me - less than $2,000.
She was putting up a 5% downpayment and requested a 40 year amortisation. (Unlike today where the maximum allowed is 35% and will drop to 30% in March 2011)
The mortgage insurance premium was so high for this mortgage ($39,889 !!!!) her actual mortgage was $644,279 - even though the purchase price was only $636,200.
The five year interest rate for her mortgage was 5.84% - meaning a basic mortgage payment of $3,442.25 plus property taxes plus utilities every month.
She was also servicing a car loan for $558 per month.
OK - I submitted the deal and was approved with ease for a high ratio insured mortgage.
Now, where is the sanity check here? As mortgage broker agents, we are given comprehensive underwriting guidelines for each of the major lenders we deal with. If our deal complies with their guidelines, we place it there. We are commissioned sales people - paid by the lender for placing deals with them.
And if this same deal was submitted by a bank employee - the result would likely be no different. Only here, the employee is simply doing their job, earning their salary.
The lender has multiple layers of defense to protect itself from bad deals.
The underwriter; their supervisor; the closer (the person who gathers documents); and the mortgage insurer and their staff too. As an aside, many lenders also escalate a deal to a committee or higher authority when it exceeds half a million dollars.
I do recall being quite concerned nonetheless - and quizzing this lady as to how she intended to pay the monthly obligations. She was very confident. Her two adult sons, one with a fiancée, were going to move in with her and pay significant rent of around $800 each.
I let the matter go - right or wrong - I never said I was saint - it was my chosen profession to place qualified mortgages with eager lenders - and this deal qualified.
A couple of months later the shit hit the fan. The lady never made a single mortgage payment. She was not able to extract any money from her layabout sons - and she had a slow month in the business, and simply gave up before she had even started.
The bank began collection proceedings and eventually foreclosed the property.
I was grilled as to how this happened - it was hard for the powers that be to accept this deal had been underwritten legitimately - surely Ross had fudged something - but no, I had done this by the book.
But for some reason, in those times, this deal was doable.
After the recession struck in mid 2008, the Canadian media blamed the USA mortgage market for the catastrophe. Poorly underwritten deals etc. etc. We in Canada were "so much smarter and risk averse" than our American cousins.
I think the truth lies elsewhere. We were headed down the exact same path as the Americans - they just had a head start is all.
Back then, the industry buzz word was "Sub Prime Mortgages" - a host of lenders existed simply to underwrite deals that would not normally deserve our attention - and the lenders were aggressively pursuing the clients - just as they had been in the States the previous few years.
