Why Canada Doesn't Have a Foreclosure Problem

canadaWhy are Canada's homeowners less likely to face foreclosure? Fewer than 1 percent of Canadian mortgages are in arrears, compared to the 2.9 million homeowners that received foreclosure notices in the U.S. in 2010.

You might think it's because there are a lot fewer Canadians, and you'd be right on that score. Canada's population is just 34.3 million, while the U.S. population now exceeds 307 million. But foreclosure rates are as high as 20 percent in the hardest hit states, so population alone does not explain the difference.

Canada avoided the housing bubble that both the U.S. and the U.K. faced. That's thanks to the more conservative banking practices in Canada. Canada has stricter underwriting standards, and the banks must set aside more money toward potential losses if the market takes a downward turn. Also, Canada has no secondary market for mortgages, like Fannie Mae and Freddie Mac, which means banks can't sell off their risky mortgages, so they don't make them in the first place.

Not only are the banks more conservative about lending, but private mortgage insurers have more control over mortgage approval. Any Canadian who puts less than 20 percent down on the house must pay the full cost of mortgage insurance upfront; and the mortgage insurance company has the authority to approve or reject the property appraisal. This gives banks and buyers a strong incentive to get realistic property appraisals.

When people apply for a mortgage in Canada, there are some significant differences to the type of mortgage they'll get. Most Canadian mortgages are for 25 years, and the interest rate readjusts to the current interest rate every five years. This encourages Canadians to pay off their mortgage faster. There are also substantial prepayment penalties that discourage refinancing, especially to tap equity.

Another big difference is that Canadians don't get a tax deduction for mortgage interest, so they don't have an incentive to keep paying on a mortgage. The U.S. tax incentive for mortgages may soon be reduced as part of the deficit reduction efforts to be considered in this Congress.

If you have a mortgage in Canada, you can't just walk away. Canada has full recourse on mortgages, which means you must pay off the mortgage even if the bank forecloses on your home. If the bank forecloses and the house is
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worth less than the mortgage, the bank can sue for a deficiency judgment. The bank can then attach a lien to other assets and garnish future wages. Some states in the U.S. are full-recourse states, but others, such as California, are not.

Canada does not encourage homeownership for low-income households. Instead the Canadian government provides public funding for low-income rental housing. So you won't find subprime lending in Canada.

In reality the Canadian system is not that different than the home financing rules that used to be in place before the speculative housing market that led to the U.S. housing bubble. Prior to the boom years, banks required information to prove income and held to strict income standards. Banks also held appraisers to higher scrutiny. That's what Canadian banks continued to do, while the U.S. and U.K. lowered their underwriting standards.

Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Personal Bankruptcy and The Complete Idiot's Guide to Improving Your Credit Score.

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