Canada's housing boom is increasingly driving homebuyers to seek mortgages from private lenders, who demand rates that can be more than five times higher than those charged by the nation's banks.
Canadian house prices have risen 36 per cent since June 2009, according to the Teranet-National Bank house price index. At the same time, Canadian banks have become more conservative and regulators are making it harder to lend, giving rise to an alternative market, including Canadians who refinance their own homes at low rates and then use the money to become mortgage lenders themselves.
Some analysts say a housing investment is increasingly risky because the pace of price increases has vastly outstripped wage growth, all amid a time of historically low interest rates and record debt levels. If and when interest rates rise, the concern is that consumers would have little ability to increase their payments, because they have so much debt.
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"The risk arises if the unintended consequence of regulation is to push out the risk profile of the less regulated sector, and to encourage it to grow quickly at the same time," said Finn Poschmann, vice-president of policy analysis at the C.D. Howe Institute.
"In dollar terms it is not a huge part of the economy (but) my concern is that we pay attention, because small problems sometimes get unexpectedly large, and quickly so."
Mortgage broker Lou Perrotta said that in terms of volume, 20 per cent to 30 per cent of the mortgages he puts together are now privately financed, typically because borrowers are declined for a bank loan for reasons like a low credit rating or unsteady income. That represents about $4 million to $5 million of the $20 million of mortgage business he does annually, he said.
"Business is brisk, without question. (It has) probably tripled in the past three years," said Perrotta, president of Domus Financial Corp in Toronto, where house prices have increased by 55 per cent in the last six years.
'It's not for the faint of heart'
Perrotta acts as a matchmaker between individuals who have money to lend - and who are seeking higher rates of return than can be had in stocks or bonds - and borrowers who are willing to pay a higher mortgage rate to get into the market.
He also invests his own money, lending between $25,000 and $250,000 each to "five or six" borrowers a year who offer a good balance between risk and return.
"It's not for the faint of heart, and you need to understand the dynamics of real estate," Perrotta said.
One private lender, who asked not to be named because she is close to the real estate market and fears hurting her business, took out a C$400,000 mortgage on her paid-off home at 2.49 per cent and then gave that money to a broker that lent it to a borrower at a higher rate, for a fee.
"Who the hell is going to give me 9 per cent return?" said the lender, who said she has recourse to the borrower's assets if he defaults.
Shadow lending 'growing very fast'
CIBC senior economist Benjamin Tal said the shadow lending market represents about 4 to 5 per cent of Canada's overall mortgage market.
"This is something that is growing very fast, because many borrowers are not having access to banks because the banks are highly regulated," said Tal.
In Ontario, Canada's most populous province, private lending accounts for about 4 per cent of new mortgage originations, or $1.1 billion, or 2 per cent, of total mortgage lending by dollar value, according to Teranet.
While that's a fraction of the sub-prime lending that got the U.S. housing market into trouble seven years ago, analysts are concerned that the market is growing rapidly and may be concentrated in hot housing markets such as Toronto and Vancouver where a sudden downturn could take hold.
The practice is legal, and can be done through a person-to-person loan, in which the lender is named as a lienholder on the mortgage, or through a Mortgage Investment Corp, in which investors can pool their money to lend to those who either don't qualify for a traditional loan.
While major Canadian lenders offer five-year fixed mortgage rates at about 2.5 per cent to qualified borrowers, rates in the private market range between 7 per cent and 15 per cent, one mortgage broker said.
Traditional lenders also send business to alternative lenders, feeding the pipeline.
Royal Bank of Canada, the country's biggest bank, said when a client does not qualify for a mortgage, the bank will recommend an alternate lender, which may include a trust company, a mortgage broker or a private mortgage corporation, an RBC spokesman said in a statement.
Canada's financial system regulator, the Office of the Superintendent of Financial Institutions, said it monitors the alternative mortgage market but would not comment on its size, whether it was growing or whether OSFI had any concerns.
Anthony Croll, vice president of Individual Investment Corporation, a Montreal-based private lender that has been in business since 1958, said he's seen a rise in the number of small private lenders over the last few years competing with the 10 per cent to 12 per cent interest his company would charge.
He also thinks inexperienced lenders may be underestimating the risks associated with non-payment of a loan.
"Occasionally an accountant or someone else has said - after hearing about our rates, or what the deal is - 'I can do that myself,'" Croll said. "But you know everything is easy and fine to do until you have a problem."