Mortgages For All

How over-leveraged homeowners are turning to private lenders and threatening the economy

There are many qualities that make a good homeowner. Aaron Miller had none of them, and the banks knew it. He wasn’t good with tools or money. As a self-employed contractor in film and television post-production, his job security was precarious. His credit history was spotty at best. He and his wife, Jenna, whose names have been changed for this article, had three kids, and the prohibitive cost of daycare kept Jenna at home, which put them at a financial disadvantage. But they wanted a house of their own, and by 2004, with his family’s help, they had accumulated a nest egg of $70,000.

They wanted to put that money down on a $317,000 could-be-charming Victorian semi in Dovercourt Village. “It was a rooming house,” recalls Aaron, “so it had been carved up into lots of small rooms. We planned to fix up the kitchen and the bathroom. Jenna wanted to make it the house of her dreams.” But the mortgage shopping didn’t go as well as the house shopping. They went to a broker, who hooked them up with Meridian, Ontario’s largest credit union, to secure a mortgage. Luckily, Meridian didn’t require someone else to co-sign.

Within the first year, they realized the house needed more work than they had thought. The basement was damp, its walls rotting with moisture. The windows were ancient single panes in wooden frames, which made the house expensive to heat. One of those windows was in a shower stall, the shower head spraying directly onto it. Aaron had noticed this before buying the house, of course, but as a first-time homebuyer he hadn’t realized that a hot, soapy, near-constant stream running down the inside of a window might accelerate damage. Every time he tried to do some simple repairs, he’d discover faulty wiring or waterlogged drywall. “The house wasn’t about to fall over,” he says. “It had good bones. But it should have been a full gut job from the beginning.”

Back then, he and Jenna still believed they could whittle away at the repairs bit by bit. Since they didn’t have any cash to hire a contractor, they took out a second mortgage on the house, this time with CitiFinancial, a Canadian arm of the American behemoth Citigroup. Thanks to their substantial down payment and their thus-far-spotless record with Meridian, Citi was happy to extend them a smaller loan on favourable terms. They borrowed $30,000 and bought the materials they needed to fix up the house, but couldn’t find the time to do any of the work. “There was lots of deconstruction of the house, but no construction,” says Aaron. “The IKEA kitchen never made it out of the box.”

Even before taking on the Citi loan, Aaron was working longer hours than ever to support his family. He was getting crushed under the stresses of his job, his house and his financial commitments, unable to get on top of any of them. And then, shortly after taking on the second mortgage, the work dried up. Instead of getting ahead on the renovations, he was scrambling to find new employment. “A self-employed friend of mine told me, ‘You’ve got great credentials but you’re not hirable. You’re too ineffective because you’re burnt out,’ ” he says.

That’s when the Millers missed their first mortgage payment. “I paid the first month on the second mortgage but was late the next month,” Aaron recalls. The people at CitiFinancial were patient at first, but after six months of late and missed payments, they’d had enough. Aaron and Jenna received a letter from Citi’s lawyers, threatening them with foreclosure. The letter demanded they pay off the remaining principal, plus the missed payments, plus default penalties for each late payment, plus legal fees, which totalled into the thousands.

The Millers weren’t ready to give up on themselves or the house yet. So they went to a new mortgage broker, who connected them with a private lender willing to take over their second mortgage. They rolled everything they owed Citi into the principal of the new second mortgage, which ballooned from $30,000 to $50,000. The new mortgage also came with a higher interest rate of 10 or 12 per cent—Aaron doesn’t remember the exact number—“that was too many loans ago,” he says. “Our financial situation was already snowballing out of control.”

Aaron, still out of work, started to miss payments on the first mortgage and was on the phone constantly with Meridian, making arrangements. The situation turned dire when their new second mortgage came up for renewal. It’s standard practice in the world of private lending for mortgages to have terms of only one year, and for lenders to charge a renewal fee. But the Millers’ renewal fee was 15 per cent of the principal, more than $7,000—an astronomical sum even by private lending standards, designed to push them out of the home and force its sale. “That clause was in the paperwork somewhere, but I don’t remember seeing it,” Aaron says. “I had to come up with the money right away or we were going to lose the house.”

The financial sector has no shortage of doublespeak to describe Aaron’s situation. His credit record wasn’t bad, it was “bruised.” He didn’t default on his loans, his mortgages were simply “non-performing.” The private lender wasn’t a shark but a “less-regulated lender.” His loan wasn’t subprime, it was “non-prime.” And Toronto is where all the euphemisms converge: non-prime mortgage lending to bruised-credit borrowers by less-regulated entities—better known as “shadow lending”—has existed for ages, but it has been on the rise over the last few months in this city, and elsewhere in Canada as well. The Bank of Canada is nervously keeping tabs on the non-prime trend and in the past year has begun sounding alarm bells. “A sizable proportion of new, uninsured mortgages are being issued to riskier borrowers,” it announced last December, calling the situation “worrisome.”

The difference between the terms subprime and non-prime is largely semantic. A prime mortgage is a lender’s qualitative assessment that takes into account the quality of the borrower, the home and the loan. Subprime mortgages, obviously, fall below this standard, and during the American crisis of 2007 a sea of mortgages missed the mark on all three counts: the borrowers weren’t creditworthy, the homes were overvalued, and the loans featured “teasers,” or low interest rates that automatically increased after a brief introductory period, and that the borrowers, since they were uncreditworthy in the first place, couldn’t afford. Even at its height, American subprime borrowing accounted for only 20 per cent of all mortgage loans. But when those borrowers began defaulting in waves, it was enough to spark a market crash, a series of bank failures and shotgun mergers, massive bailouts, and a global meltdown.

Non-prime mortgages, or near-prime as some institutions call them, are those where only one of the three factors falls short. Usually it’s the borrower, who may not have a biweekly paycheque or an ideal credit rating, but—on paper at least—the mortgage payments are affordable and the property makes for sound collateral. The “non-prime” and “near-prime” coinages are distinctly Canadian in their low-risk intonations, offering reassurance that these loans are better than the American ones. But they are still dicey loans.

And the federal government has helped to create them. Federal regulators recently increased the amount of reserve capital the major banks must keep on hand to guard against losses, which has tempered the banks’ lending. And Ottawa has tightened the qualifications for mortgage insurance: the maximum amortization period for an insured mortgage is now 25 years, down from a high of 40 years back in 2008. The government also capped the amount of total debt households can carry: if your monthly mortgage payments plus your other bills amount to 40 per cent of your income or more, neither CMHC nor any private insurer will insure your mortgage.

A key purpose of all these regulations is to prevent people who can’t afford a mortgage from ever getting one in the first place. On that score, they have failed. The regulations have done nothing to stem access to credit; they have merely created a stronger market for alternative lenders. Any schmuck can get a mortgage, and a great many of them do. If the major banks reject them, there are dozens of other lenders that won’t. Home Trust, a major non-bank lender that issued roughly $9 billion in mortgages last year, states on its website that it caters to new immigrants and people with checkered credit histories. The website for Equitable Bank, a small, branchless bank that issued more than $2.3 billion in residential mortgages in 2014 (a vast increase from the $1.6 billion it issued in 2013), trumpets its aptitude for finding ways to justify a loan beyond the standard Beacon scores. Subprime borrowers can also turn to mortgage investment corporations, in which shareholders pool their funds to invest in residential real estate; Northwood Mortgage, a brokerage that advertises heavily on the AM dial, also runs a mortgage investment corporation to underwrite non-prime deals. Then there are private mortgage lenders, the kind who took over the Millers’ second mortgage: individual investors, alone or in partnerships and syndicates, who invest their money in other people’s homes.

They all charge an interest premium—the riskier the client, the higher the rate. I met one private lender who explained to a client that it would cost $5,000 to set up a $15,000 mortgage—meaning the loan would end up being for $20,000, at 10 per cent interest. It’s an arrangement only a desperate borrower would make. At Home Trust, the interest rate on what’s termed their Alt-A mortgage, for the least risky of the risky borrowers, is 4.64 per cent for a fixed five-year term, far beyond the 2.59 per cent they charge prime borrowers. Rates for private lenders usually range from seven to 15 per cent, but they can, in theory, go far higher. Under the Criminal Code, only rates above 60 per cent per year are illegal. Why would anyone pay double-digit rates at a time when the prime lending rate at most banks is well under three per cent? The obvious reason is that no one will lend to them at prime. But they’re also betting on themselves: if they can make those payments for a couple of years and improve their credit rating, they might be eligible for a prime mortgage, or at least a better rate, at renewal time.

Above all, though, they are betting on the Toronto market. In some neighbourhoods, most notably Leaside, Cabbagetown and Yorkville, detached home prices have averaged 10 per cent price increases per year for the last 19 years, even after adjusting for inflation. The same is true of condos in much of downtown: Riverdale condo prices, for instance, have risen 195 per cent since 1996. And the market is only getting hotter. Detached home prices across the 416 area code increased by an average of 12.9 per cent over the past 12 months. With numbers like those, a six or seven per cent interest rate on a mortgage looks like a pretty good deal. Even a 10 or 12 per cent interest rate can seem sound, if borrowers think the market will stay buoyant. That’s how hot Toronto’s market is: people will not only pay an increasingly steep price to get in, but they’ll pay a premium interest rate to stay in. They’ll borrow from whomever they have to.

Research by CIBC shows that eight per cent of all new mortgages in Ontario are non-prime. The Bank of Canada’s figures are more alarming: they suggest that roughly 35 per cent of all new mortgages issued by smaller banks—the ones the bank doesn’t consider “systemically important”—could be considered non-prime. As for private lenders, 100 per cent of their loans are non-prime, because that’s their business model: serving the borrowers that prime lenders won’t. By and large, these private mortgages are not insured against default because the borrowers make a substantial down payment. But down payments in this city are often not what they seem. According to a recent study by the Canadian Association of Accredited Mortgage Professionals, Canadians borrow more than $10 billion annually just for down payments—which means they aren’t really down payments at all, just loans piled atop loans. The Bank of Canada has singled out this trend in its reports: if down payment loans become too prevalent, it says, stating the blindingly obvious, “they may reduce the effectiveness of financial system safeguards.” Buying a home is supposed to be an investment in the future, but it’s looking more and more like a liability, not just for individual homeowners but for the entire economy.

The phrase “shadow lending” conjures up all sorts of nefarious imagery: back alleys, manila envelopes, shakedowns, tire irons. Private mortgage lending, for the most part, looks nothing at all like that. Mortgages aren’t drug deals but registered loans, and private lenders aren’t kingpins with thugs who break kneecaps. They are ordinary people with money to invest and a taste for a particularly human kind of risk.

I met one private lender—I’ll call him Jeff—who agreed to be interviewed in exchange for anonymity. He lives north of Toronto in a 1980s suburban-style house with a double garage whose most appealing feature, for Jeff, was the sprawling, densely treed yard that preserves his privacy. Jeff is no shark, though he is something of a Cheshire cat. He is soft-spoken, friendly and infectiously calm. He spent much of his career as a Bay Street banker. Now in his 60s, he lives off the proceeds of his personal mortgage lending business, which he runs out of his home in between trips to the Caribbean. Call it Jeffbank. “I earn enough to have a nice life,” he says with a grin.

Jeff doesn’t advertise his services. His borrowers find him through the mortgage brokers and lawyers who know him, and whom he trusts. He says his primary line of business is first mortgages for homes in the Toronto area, which means he’s got hundreds of thousands of dollars tied up in each loan. He declined to say how many mortgages he bankrolls or how many millions he’s invested in total, but he typically charges interest of 6.99 or 7.99 per cent on a first mortgage, depending on the client. He also holds some second mortgages for lower dollar amounts, but, as he puts it, “I’m not a $20,000 guy.”

Jeff generally operates according to standard practice for private lenders. Setting up a private mortgage always incurs a series of initial charges: broker fees between one and five per cent of the loan, lender and administration fees of one to two per cent, and legal fees totalling roughly $1,000. His mortgages tend to have very short terms, usually a single year. When the term is up, the fee to renew the mortgage is typically one per cent. For people who’ve only ever borrowed from big banks, such fees can be shocking, but in private lending they are common. Jeff explains all these costs at the outset, giving his clients the chance to pay them willingly or walk away.

Jeff is a shrewd underwriter of risk and judge of character. He takes the time to lay eyes upon every borrower and every property he invests in. “A lot of mortgage lending is paperwork, but there’s a human dimension to it as well,” he says. “There are lots of legitimate reasons why someone might miss a payment. The borrower and the lender need to have a discussion about the accommodations they will make for each other.”

More to the point: once borrowers are 15 days late on a single mortgage payment, they are legally in default, and on day 16, any lender, from Scotiabank to Jeffbank, can begin foreclosure proceedings. The banks never do that, of course—they wait for mortgage holders to be multiple months in arrears before giving up on them—and neither does Jeff. When his borrowers become unable to make payments, he’ll sit down with them and try to talk sense. “I say to them, ‘Look, it’s not going as planned, and let’s not sell the house under legal duress,’ ” he explains, because once lawyers get involved, the timelines will be strict and the process can become adversarial. “We are better off putting the house up for sale quickly and making new living arrangements without legal pressure.” Ideally, though, it never comes to that. As Jeff puts it, “You don’t want to push the borrower beyond their ability to pay.”

Unless, of course, you are the kind of lender who wants to do precisely that. Not all private lenders are as patient or even-handed as Jeff. They aren’t regulated by any government agency. One borrower I spoke to, named Janice, decided four years ago to deal with a private lender to consolidate $25,000 in outstanding bills and credit card debt she’d incurred to send her daughter to university. Her lender, who was also a mortgage broker, told her the interest rate would be six per cent, upon which Janice signed 12 postdated cheques to set up withdrawals. She later found out the interest rate was 15 per cent. She says her lender never mentioned the $10,000 in setup fees, which turned it into a $35,000 loan. At year’s end she was hit with a renewal fee and other charges, so that the principal jumped to $42,000. Janice, who owned her home outright, decided to remortgage the property with a reputable institution to pay off her private lender. That’s when he registered a second mortgage on her home without her knowledge. Once she missed her payments, he initiated legal proceedings to seize the house. Janice bolted. She is now living in a basement apartment. The lender sold her house in August for $200,000 and garnished her wages in lieu of payments on the second mortgage.

Aaron and Jenna Miller spent nearly a decade fighting an uphill battle to stay in their home. They had gotten around the problem of the renewal fee by finding yet another private lender to take over their second mortgage. But as time went on, they fell behind on their first mortgage, until Meridian eventually gave up on them. With the help of a broker, they found a new consortium of private lenders and restructured all their mortgage debt yet again.

When they first bought their house in 2004 with that $70,000 down payment, their total mortgage was $247,000, and their monthly payments were $1,420. Ten years later, their total mortgage debt was roughly $370,000, more than they’d initially paid for the house. A consortium of three private lenders now held their first mortgage, which totalled $345,455 and came at an interest rate of 7.9 per cent. Another private lender held a $25,000 second mortgage at 12.9 per cent.

Every new mortgage offers a new beginning. Aaron and Jenna had every intention of honouring the debt. They figured it would be worth it, since homes in the neighbourhood were by then selling for well over $600,000. But if they couldn’t manage their mortgage payments beforehand, there was no way they would be able to afford them now. Their combined monthly payment had skyrocketed to roughly $4,000. Aaron hadn’t completed any significant repairs to the property. The stress was taking a toll on their marriage, and on him personally. “I might have walked away were it not for my family,” Aaron told me. They defaulted on both mortgages in early 2014, and once again found themselves facing foreclosure.

Whether it’s a bank, a trust or a private investor, when your mortgage lender gives up on you, the balance of power shifts heavily in their favour. They hand your file over to a lawyer, whose first move is to serve you with a Notice of Default demanding that you bring the mortgage back into good standing within 30 days. If you fail to pay up, your lender has a choice to make: foreclosure or power of sale. Under foreclosure, your mortgage lender evicts you and takes title to your property, including all your equity. Power of sale is a different kind of default remedy: rather than taking title to your home, your lender simply sells it from under you and uses the proceeds to pay off your debts: mortgages, property tax arrears, property liens. If there’s any money left after everyone’s been paid, you get to keep it; if not, your lenders can still come after you for any remaining balance on your mortgage loan.

Foreclosure has become increasingly rare, because it can take up to eight months and incur thousands in additional fees. Power of sale is cheaper and quicker: the whole process can be wrapped up in less than four months. It begins with a registered letter, titled Notice of Sale Under Charge, which gives the homeowner one last chance to bring the mortgage back into good standing. The Notice of Sale is a sobering ledger of indebtedness: its line items include the entire principal of the loan, all outstanding interest, late fees, administration and maintenance fees, interest on arrears, next month’s instalment (which must now be prepaid), property taxes and the lender’s legal costs, which, per standard procedure with any mortgage, are passed on to the borrower.

By mid-2014, the legal costs on the Millers’ $25,000 second mortgage had jumped to more than $11,000. Including all the penalties and fees, they owed $54,564, more than double the initial amount. Of course Aaron and Jenna could never pay up, but at this late stage no one expected them to. They and their kids were about to be evicted. Aaron knew this was the end, and he was beyond casting blame. “The situation wasn’t any bank’s fault or any lender’s fault,” he says. “They were just doing what they do.”

Ron Alphonso
Like most private lenders, Ron Alphonso offers mortgages with high interest rates and renewal fees. But in an industry of predators, he has carved a niche helping borrowers in default. In the last five years he has arranged or extended loans to some 300 homeowners, many facing power of sale, and often for the purposes of renovating to prepare for listing. (Image: Dave Gillespie)

In desperation, Aaron and Jenna went to the Internet looking for last-ditch help. A Google search led them to, which offered the chance to stop the legal proceedings. That’s how they met Ron Alphonso. He’s a 57-year-old private mortgage lender and mortgage agent who operates out of his home, an ordinary suburban bungalow in north Toronto. His private lending portfolio for second mortgages typically ranges from $25,000 to $75,000, though he does hold some first mortgages and larger amounts as well. In recent years, he has carved out a profitable niche for himself doing business with people who are facing foreclosure.

Alphonso typically visits lawyers’ offices to pay off his clients’ debts and to buy them time. There are dozens of small law offices that handle real estate transactions, which by the nature of the business includes foreclosures and powers of sale. In any given month, the big banks have about 3,000 mortgages in default in Ontario alone, and to handle them they rely heavily on two firms. One is Chaitons, at 5000 Yonge, north of Sheppard. The other is Gowlings, one of the city’s largest and most prestigious firms. Gowlings is headquartered on Bay Street, but their office for what they call “recovery services” is in Hamilton, where they have a full floor dedicated to the practice. “It’s a volume business,” says Alphonso.

When I visited his home office, the kitchen table was piled high with files featuring Notices of Sale and NSF cheques of defaulting homeowners, all needing his active attention. Alphonso spends much of his time on the road, travelling to and from homes, banks and legal offices, trying to get everyone on board with his plans.

“When I first started out as a private lender, if a mortgage went sour I sent it off to the lawyers like a good boy because that’s what I was supposed to do,” he says. “Except that, after a while, I started to notice that nothing good ever happened.” People who default on their mortgages come in all stripes: deadbeats, the newly divorced, overextended well-to-do types and people who have been defeated by the demands of home ownership. As they lose their grip on their finances and fall behind on their payments, they often become experts at dodging phone calls and ignoring letters, which drags the process out needlessly—and, from Alphonso’s perspective, only pumps up the late fees and legal bills. In his experience, people who haven’t been making their payments often haven’t been maintaining their properties well either, which hurts their resale value. Alphonso has seen this scenario enough times to know how it ends: both the homeowner’s equity and the lender’s principal get eroded by bloated fees and a bad sale price, and everyone takes a loss except the lawyers.

In a real estate market as hot as Toronto’s, that should never happen, no matter the circumstances of the sale. Given a little spit-shine, any home in the GTA can command a premium right now. Alphonso has figured this out, and what he offers to people facing foreclosure and power of sale is the opportunity to regain control over their situation. His website claims he can help keep people in their homes. But once foreclosure or power of sale proceedings have begun, it becomes increasingly hard to do. “My first question to people is, ‘What do you want to do?’ ” he explains. If they say they want to fight to keep the house no matter how dire the circumstances, he says goodbye. “But if they say they want to sell before they get foreclosed, then I can help.” Alphonso says homeowners need to realize that once lawyers get involved, the owner will be leaving the house one way or another—on their own terms or someone else’s.

Earlier this year, Ellen Locke, who also requested that her real name not be published, hired Alphonso to stop power of sale proceedings against her. Seven years ago, back when she had a good job as the manager of a daycare centre, Locke purchased a 900-square-foot bungalow near the Scarborough GO station for $285,000. She took out a mortgage with Royal Bank, the kind that’s no longer permitted under today’s rules: a five per cent down payment ($14,000) and a 40-year amortization. After about 18 months, her life became a litany of misfortune. Her partner, whose name wasn’t on the mortgage but who was helping to pay the bills, died. Then she lost her job. A succession of basement tenants were always late with their rent. Since Locke had no money to maintain the house, it began to fall into disrepair. “I was always on the phone with Royal Bank, making arrangements for late payments,” Locke, now 51, recalls. “Then my tenants wouldn’t pay their rent. I felt like I was working so other people could enjoy my house.”

When Royal Bank finally sent in the lawyers, Locke found Alphonso’s website. She was ready to sell, and she gave Alphonso permission to negotiate with her creditors on her behalf. “I’m not a lawyer, but I know many of the real estate lawyers in town and they know me,” Alphonso says. “And I know exactly how the process works. So I go to them and I tell them that the homeowner has a new plan, and I lay it out for them.” In Locke’s case, the plan looked like this: Alphonso would extend her a short-term second mortgage of $25,000, which he would use to fix the house up before putting the property up for sale. “Usually I do only as much as I have to do to get the house ready,” Alphonso says. “We are always working against time. If there’s any delay, the legal proceedings can pick up again.”

Locke never touched a penny of Alphonso’s $25,000 loan. He disbursed the money himself, hiring crews and paying for supplies, which is how he always operates. He brought in a dumpster and filled it with the detritus belonging to her deadbeat tenants. Alphonso also cleaned up the enclosure and the garage, which had turned into a junkyard. He tore down a smoking shed Locke’s tenants had built on the front porch. He gave the place a fresh coat of paint. He then hired a real estate agent to put the house on the market at a price designed to spark multiple bids.

In theory, once Alphonso closes a deal like this, all the lawyers and creditors get paid—including Alphonso, of course, for all his services. “I need to be able to make at least $6,000 on a job to take it on,” he says. “Ideally, the fees should amount to between $10,000 and $15,000.” On the surface, there’s something unsavoury about Alphonso’s business model, which profits from people in dire straits. But it’s wishful thinking to believe that Locke, or anyone in her situation, with their financial and personal lives in disarray, can somehow pull themselves together and, in the space of four to six weeks with lawyers threatening eviction, do all the things Alphonso does. His presence changes the nature of the sale, and the behaviour of all the parties involved, because he is an active agent in maximizing the value of the property—the magic ingredient missing from most power of sale proceedings.

Locke’s house sold last June for $475,000, and she walked away with $112,059 in her pocket, more than eight times her initial down payment. That’s after the proceeds from the sale had cleared away all her mortgage and personal debt, including the $14,250 she paid Alphonso. “It was more than worth it,” she says. “The fact is that I didn’t have the money to do the work that needed to be done.” And who else was going to lend it to her, when Royal Bank had already written her off? Locke now lives in a basement apartment in Mississauga, debt-free for the first time in her adult life. “Friends ask me, ‘Do you miss owning your own house?’ The answer is no. I couldn’t be happier.”

The decrepit condition of the Millers’ home presented a far greater challenge than Locke’s. By the time Alphonso got involved, Toronto Hydro had cut the Millers off, and the house was a maze of half-demolished walls from Aaron’s attempted renos. “I told the real estate agent to wear a hard hat when she went in,” Alphonso says. There was no point spending any money to fix it up because, well, where to start? The best Alphonso could do was a basic cleanout and cleanup. The house would have to be sold as-is. Its only saving grace was the fact that it was on a good street in a good neighbourhood. Similar homes in the area were by then selling for well above $650,000. Alphonso put a stop to the legal proceedings against the Millers. He extended them a $70,000 loan to put a down payment on another, much cheaper house, which allowed them to move out right away. Without that loan they’d have been evicted, penniless and homeless with their kids until the house sold, and no one knew how long that would take.

The Millers cleared out in late September 2014 and the house went up for sale. It sold for $555,000, of which $465,000 was used to pay out their outstanding mortgage, property taxes, and legal and professional fees. There was enough left over for the Millers to pay back the $70,000 and pocket roughly $18,000 in cash.

Mortgages For All

From left: Just before the owner of this home near Danforth and Jones tried to sell, he was evicted. He owed $180,000 on a second mortgage. The place sold for $787,500 in May 2015; Middle: The owner of this Scarborough condo fell behind on two mortgages, refused to sell and was evicted. The place sold under power of sale for $302,500 in February 2015; The owners of this home near Eglinton and Caledonia were evicted last summer after falling behind on their mortgage. The house sold under power of sale for $750,000. (Images: Dave Gillespie)

The Millers’ story offers two crucial lessons for homeowners in this city. The first is absolute: don’t take on more debt than you can afford. The second is situational, a reflection of this unique moment in Toronto’s history. If you’re already in over your head, sell now while prices are inflated.

The Canadian housing market is overvalued by as much as 20 per cent, according to the International Monetary Fund; the Bank of Canada puts it higher—at 30 per cent. The Economist says 35. And two cities, Toronto and Vancouver, are the ones whipping up the most froth. Home prices in the GTA experienced double-digit increases in August, with detached homes in Toronto now averaging over $1 million and those in the suburbs averaging $733,000. Also in August, CMHC issued a report indicating the Toronto market was at high risk for a correction. What’s unclear is when house prices will adjust, how quickly and by how much.

For the time being, high prices have the ability to forgive even the most egregious disasters of household negligence. The Millers are the perfect example. They bought a bad property and over the course of a decade made it worse. Yet at the time they sold, it had appreciated by an astonishing 80 per cent. “If the market isn’t strong, they lose everything,” says Alphonso.

And if the market isn’t strong, chances are Alphonso doesn’t help them out. Alphonso is a nice guy, but he’s not a saint. He extended that bridge loan to the Millers only because he was confident the house would sell at a high enough price to pay him back, with interest. If prices had fallen by, say, 30 per cent last year, the Millers’ home, instead of selling for $555,000, would have sold for less than $400,000. Their debts would have swallowed every last penny from the sale of the house and left them on the hook to their lenders for tens of thousands more. They’d never have been able to pay it, of course, so their lenders would have lost money too.

“This is not a normal, healthy real estate market,” says David Madani, a former Bank of Canada senior economist who now works for the private research firm Capital Economics. He has been issuing warnings about the market since 2011, which was around the time prices became unmoored from such key indicators as income and housing rents. He believes the Toronto market is defying gravity, and he does not fall for the hoary talking point parroted by every real estate agent and mortgage broker in the city: home prices will keep rising because the population keeps growing, providing a constant influx of new demand for existing supply. What keeps the housing market so hot is not population growth, but credit growth. “The amount of credit households are allowed to borrow is the more important factor,” Madani says. “Homebuyers and investors believe that house prices will keep rising indefinitely, or remain high permanently.” So they keep asking to borrow more, and lenders keep creating loans to satisfy the demand.

The bubble has never been more buoyant, and low interest rates are its helium. Low rates keep prices high. They make borrowing attractive, whether it’s prime or non-prime. They also keep default rates down: everyone can afford their house when interest rates are at all-time lows. Right now, every mortgage looks great on paper and every homeowner is worthy of their loan.

But that could all change in an instant. As Madani puts it, “You never know the true quality of a loan until you get an economic shock.” The trigger could be a rise in interest rates, which will increase monthly payments for anyone with a variable-rate mortgage. It could be a hard landing for the economy of China, whose stock market took a beating throughout the summer and whose ripple effects could spread globally just as the U.S. subprime crisis did. It could be a worsening of the recession here at home. Ironically, notes Madani, the only things keeping the Canadian economy from total collapse right now are the Toronto and Vancouver real estate markets.

The Bank of Canada continues to predict a “soft landing” for the real estate market, in which construction slows, sales decline gradually and prices decrease slightly. But the riskier the loans get, the less likely a soft landing becomes. Whatever the shock is, it will hit subprime borrowers first, followed in close order by non-prime borrowers. Mortgage lenders will realize what’s happening and act rationally. They will be less patient with borrowers in arrears, because they will want to get those homes up for sale before prices decline by too much, in order to recoup their investment. Even if borrowers are making their payments, when renewal time comes at the end of the one-year term, lenders can simply decline to renew and call in the loan, forcing homeowners to find a new lender—fat chance in a market that’s begun its downward descent—or put the house up for sale.

That’s when we will find out whether or not our housing market is as bad as the American market was in 2008. The worst-case scenario will unfold like this: a wave of homes will flood the listings, forcing prices down even faster. Households that are overburdened with debt will end up with negative equity. Bankruptcies will spike. The institutions that cater to subprime borrowers will take their lumps as they write off their bad loans. Those that are publicly traded will see their stock prices plummet. Some of them might fail, which will put stress on the rest of the financial system. The system as a whole is absolutely guaranteed to withstand the shock, simply because the government will bail it out before allowing it to fail. But if you think that’s good news, talk to your American cousins about what life was like in 2009.

Whether it’s a hard or a soft landing, when it comes, Aaron and Jenna Miller plan to watch it unfold from their new home. Their search for a more affordable place led them further and further from Toronto. They fell in love with a two-and-a-half-storey, four-bedroom home northeast of the city, which they bought for $199,000. Even there, they won’t be immune to the shock. Because of all their troubles with their previous mortgages, the banks still won’t look at them. They are still with a private mortgage lender, and Aaron continues to move from contract to contract in his work. But with smaller payments, at least they have a fighting chance of keeping their home. When he reflects on his litany of first and second mortgages in Toronto, and the way they ballooned far beyond his ability to pay for them, he says, “It’s absolute lunacy that we were able to stay in the house as long as we did.” As for having to leave the Toronto real estate market behind, the timing couldn’t have been better.

Lead photo of family by Getty Images