Subprime Borrowing Accelerates in Canada

Market observers are turning heads and raising eyebrows from a new TransUnion Canada report, revealing a substantial surge in subprime borrowing in the second quarter. The current climate of exceptionally high debt loads and deteriorating credit quality is beginning to weigh on the national economy.

The term subprime elicits a fierce reaction harkening back to the days of the 2007-2009 global financial crisis. While Canada did not endure the same meltdown as neighbours to the south, the subprime fiasco triggered a spillover effect on the wider economy.

But is Canada on the cusp of its own subprime-fuelled economic calamity? And how much might it affect the Canadian real estate market?

Subprime Borrowing Accelerates in Canada

In Canada, subprime is typically described as a credit score below 660, resulting in higher interest rates than other consumers with higher numbers. Of course, there are other factors involved when assigning subprime status to borrowers, from low income to high debt to past bankruptcy.

Subprime borrowing has become the fastest-growing credit segment in Canada, new TransUnion data show. In the second quarter of 2023, the number of subprime borrowers swelled nearly nine per cent in the last year, topping 2.64 million. Additionally, the number of high-risk borrowers expanded at close to double the rate of near-prime and prime borrowers and four times the rate of high-quality and above-prime borrowers.

For the rest of the credit market in the second quarter, the number of Canadian borrowers maintaining an outstanding credit balance increased more than three per cent from the first quarter.

In total, Canadian household debt climbed more than four per cent, or $98 billion, to $2.3 trillion in the April-to-June period.

The research found that soaring debt levels and higher interest rates contributed to higher minimum payments, impacting financially stressed consumers who are grappling with an elevated cost of living.

“Canadians, like the economy, remain persistently resilient,” said Matthew Fabian, the director of financial services research and consulting at TransUnion in Canada, in a statement. “However, the combined pressure of a high cost of living and elevated interest rates has created a payment shock, as the cost of debt has grown even heavier for some Canadian households. While some financial pressure has been offset through continued savings growth and strong employment, many Canadian consumers have accessed credit as a means to short-term liquidity.”

Despite risks that subprime borrowers typically present to the finance sector, lenders are content to lend, even in the current climate of tighter conditions and rising rates. The credit bureau reported that below-prime loan originations increased 16 per cent in the second quarter, compared to the six per cent jump for individuals with prime or above-prime credit scores.

Many economists argue that the Canadian real estate market does not suffer from a subprime mortgage problem like the United States. Before, during, and after the Great Recession, federal regulations prevented an economic collapse and the housing market from caving like a house of cards.

Even as the latest developments suggest a slowdown – soft handling or hard landing, you be the judge! –in the Canadian economy, stability is a terrific description of the Great White North, says Rob Aitken, an associate professor of political science at the University of Alberta.

“We’ve seen a lot of upheaval in many countries, whether it’s financial markets or currency markets around the world,” Aitken told The Hub in a recent interview. “Canada has a stable currency, has a stable financial system, has a stable banking system, and has this reputation of being cautious and conservative (regarding finance).”

Mortgage Payments

The size of monthly mortgage payments could be an issue for homeowners.

This past spring, the Bank of Canada (BoC) warned that mortgage borrowers who renew their home loans over the next few years could see an increase in their monthly payments. By how much? Between 20 and 40 per cent.

The reason has been the result of rising interest rates, the highest they have been in two decades. By 2026, nearly all borrowers will need to renew their mortgages, facing much higher payments.

“In light of higher borrowing costs, the Bank of Canada is more concerned than it was last year about the ability of households to service their debt,” the central bank wrote in its annual Financial System Review. “More households are expected to face financial pressure in coming years as their mortgages are renewed.”

New data suggest that homeowners are already under immense financial stress.

According to figures from the Royal Bank of Canada and TD Bank, 43 per cent and 48 per cent of borrowers had amortization periods of more than 25 years, respectively. This is up from 40 per cent and 35 per cent, respectively, from the previous year. In many instances, the lifespan of these loans has been extended to more than 35 years.

Today’s mortgage rates stand at around six per cent as the central bank has raised the benchmark overnight rate to five per cent.