People looking to buy homes in the red hot Toronto housing market have received something of a reprieve lately, as sales and prices have both declined, though the latter only modestly.
But while prices have fallen relative to the peak in early 2017, they remain significantly elevated relative to household income levels.
At the same time, household debt in Canada continues to grow, hitting $1.8 trillion if you include mortgage debt. Once all types of debt are considered, Canadian households owe $1.71 for every dollar of disposable income. Excluding mortgages, the average debt per person rests at $22,837.
The combination of prices growing faster than incomes, high debt, and regulatory changes — such as the recently imposed stress tests requiring households to qualify a significantly higher rate — can put households in a difficult financial bind.
Even law abiding individuals could find themselves tempted to embellish their earnings or understate their liabilities in the bid to secure a mortgage for their family’s dream home.
The prospect of a spike in mortgage fraud in Canada was raised in February, when the ratings agency S&P Global Ratings warned that it expected the phenomenon to increase, and potentially even pose a risk to the big banks.
With memories of subprime mortgages triggering the Great Recession still fresh, any suggestion of an elevated risk of mortgage fraud is bound to raise concerns amongst regulators and lenders.
So, could Canada be heading to a subprime-like crisis? Something that extreme seems highly unlikely, but there is a need for a greater understanding of the dynamics of the Canadian market.
The data on mortgage fraud here is slightly dated. Equifax Canada in January 2017 reported that suspected fraudulent mortgage applications had risen by 52 per cent since 2013.
Equifax noted that falsified account statements were the most common indicators of possible mortgage fraud.
Does this mean that prospective buyers are lying on their mortgage applications by either embellishing their incomes or understating their liabilities? Equifax couldn’t say for certain as it could not entirely attribute the increase in suspicious applications to “consumers overstating personal income or falsifying applications.”
Since subprime mortgage lending had a large role in instigating the Great Recession, mortgage lending has therefore come under greater scrutiny in the U.S. where information about the prevalence and scope of mortgage fraud is now more readily available.
The U.S. experience reveals that whereas households may be guilty of indulging in “little white lies” in their applications, the real harm to financial systems comes from organized mortgage fraud perpetrated by industry insiders or organized criminals. Lax standards set by unscrupulous lenders or brokers, who are motivated by commissions tied to the underwriting volumes, hold a greater responsibility than individual households whose primary motivation is to become a homeowner.
An article in Real Estate Issues in 2012 noted that the FBI categorizes mortgage fraud as “a material misstatement, misrepresentation, or omission relied on by an underwriter or lender to fund, purchase, or insure a loan.” The bureau estimated annual losses from mortgage fraud to be in the range of US$4 billion to US$6 billion in 2012.
FBI collects mortgage fraud data from Suspicious Activity Reports (SARs) filed by the federally insured financial institutions. The number of SARs increased from 26,000 in 2005 to 92,000 in 2011.
The dust is still settling on the subprime mortgage crisis in the U.S. Earlier in March, Barclays Bank was fined US$2 billion in the U.S. to settle claims by investors who purchased toxic mortgage-backed securities from the bank back in 2007.
Unlike the U.S., mortgage fraud data or estimates for Canada are hard to come by. Apart from the infrequent press releases by rating agencies and credit monitoring firms, hard evidence for the extent and scope of mortgage fraud and default is missing in Canada.
Canadian regulators and lenders must collaborate to monitor, identify and prosecute mortgage fraud in Canada. Despite the higher level of household debt, Canadian household finances are stable with consumer bankruptcies down by 1.7 per cent and 90-day-plus delinquency rate falling by 6.4 per cent year-over-year.
This is, however, no reason to be complacent. Economic conditions and household fortunes may change fast and unexpectedly. There is an urgent need to understand the economics of mortgage fraud in Canada. Vigilant and transparent monitoring of mortgage finance will build confidence in Canadian financial institutions.
Murtaza Haider is an associate professor at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached at www.hmbulletin.com.