Effective Exit Strategies — The First Release in our new Alternative Lenders Series

From 2015 to 2019, alternative lenders were the fastest-growing segment in the Canadian mortgage industry. We’re exploring the alternative lender segment in a series of pieces to better understand potential risks.

The first piece in this series focuses on effective exit strategies.

From 2015 to 2020, more homebuyers in Canada turned to alternative lenders. Factors leading to this include:

• greater demand
• rising housing prices
• low-interest-rate environment

The alternative lender portfolio increased from an estimated $9 billion in 2015 to $15 billion in 2020.

Growth slowed significantly during the COVID-19 pandemic. This is because alternative lenders reacted to rapidly changing market conditions that led to numerous investors requesting equity redemptions.¹

The steady growth of alternative lending before the pandemic and its unconventional underwriting practices have raised questions regarding the potential to introduce new vulnerabilities into the housing finance system. This is especially a concern in regions where alternative lenders’ have a large market share, such as Ontario (figure 1).

The key underwriting difference between alternative and conventional lenders is that for alternative lenders, the approval process is mainly driven by the equity built in the property. The borrowers’ cash-flow in the short term also factors into the approval process for alternative lenders.

The approval process for conventional lenders mainly considers the borrower’s ability to make regular monthly payments until the loan is paid off.

The success of mortgage loans secured through alternative lenders relies on having an effective exit strategy. A successful exit strategy means the borrower can:

• get approval by a conventional lender at the term of the loan
• rapidly sell the property to repay the loan

Key findings

Alternative mortgage loans had an effective exit strategy in 7 out of 10 loans

Our analysis revealed that in 2020, nearly 32,245 alternative mortgage transactions were closed as borrowers either switched to another lender or the properties were sold or foreclosed.

Of these, 72% had an effective exit strategy in place (figure 2). Over 23,000 borrowers successfully contracted a mortgage with a conventional lender, gaining access to a longer-term mortgage and lower interest rates. Others were able to sell their property without being delinquent on the loan.

Between 2006 and 2015, approximately 80% of mortgages had an effective strategy. In 2019, this percentage fell to about 70% (figure 3).

Foreclosures remain low but higher than for conventional lenders

Our research showed that between 2015 and February 2020, only 0.17% of alternative lender mortgage transactions involved a foreclosure.

During the pandemic (March 2020 to July 2021), the foreclosure rate remained stable (0.08%), representing just 23 properties in Ontario.

This, however, does represent a significantly higher foreclosure rate than in the conventional lending space. Despite accounting for only 12% of mortgage transactions, alternative lenders are involved in 65 to 90% of foreclosures each year.

Fewer properties with an alternative mortgage were sold in 2020

During the pandemic the number of properties sold on alternative lenders’ portfolios decreased. This contradicts the strong activity in the housing market in Toronto and Ottawa.

Support programs, such as mortgage payment deferrals, allowed borrowers to avoid default and, therefore, having to sell their property.

Successful exit strategies have declined since 2011

The success of exit strategies has decreased by 10 percentage points since 2011 and has stabilized during the pandemic. This implies that the borrowers served by alternative lenders are remaining in this segment for longer than they may have anticipated. Given the higher interest rates, this may pose long-term affordability challenges.

See the full report