While federally regulated banks dominate Canada’s residential mortgage lending market, alternative lenders, such as home equity lending companies, are carving a niche for themselves among homeowners desperate to tap into their homes’ equity.
The two most visible companies in British Columbia – Capital Direct and Alpine Credits – claim to have provided more than $1bn each in loans to consumers.
Representatives of home equity lending companies say they provide a valuable service, filling a need for Canadians unable to get loans from conventional and regulated financial institutions. Both defenders and critics of alternative mortgage lenders say more people are turning to these types of lenders because the federal government has tightened lending requirements at federally regulated financial institutions.
In fact, a report published by the Bank of Canada last year warned that “tightening bank regulation … can lead to migration of activity from the traditional banking sector” to alternative lenders.
Home equity lending companies are known for the breezy tone of their ads, one of which promised to help customers get loans approved “regardless of [their] credit, age, or income”.
These potentially misleading ads don’t sit well with many credit counsellors and foreclosure lawyers. While they say these ads don’t break the law, the public needs to understand what’s behind the catchy jingles and cheerful imagery: exorbitant costs and potential risks.
Usually, a home equity loan is short-term (i.e. two years or less) and is secured against a borrower’s home as a second or third mortgage. Regulatory filings for Capital Direct and Ryan Mortgage Income Fund show a range of interest rates, often between 10% and 15%. A small number of Capital Direct’s loans have interest rates as high as 25%. Compare this to Canada’s major banks, many of which have offered five-year fixed-mortgage rates of between 2.59% and 2.99% in recent months.
Additionally, the upfront fees charged by some alternative lenders can be significant, with some charging five-figure fees before a loan is issued.
Many home equity borrowers use the funds for home renovations or to consolidate debt. However, the loans can be used for any purpose, no matter how frivolous.
Some chartered banks also offer home equity loans, but at “very reasonable” interest rates and “little to no fees,” according to Kin Lo, an accounting professor at UBC’s Sauder School of Business.
Banks’ home equity loans are radically different from the loans offered by alternative lenders, Lo said. “[The latters’] products are being targeted toward unsophisticated and uninformed homeowners. No one who is even a little bit familiar with loans and mortgages would pay interest rates this high, and pay so much in upfront fees,” Lo said.
When alternative mortgage lenders charge high interest rates, Lo said it suggests they aren’t vetting their borrowers the way the banks are. “The high interest rates anticipate high rates of default,” Lo said.
“If the homeowners are able to borrow from a bank [or credit union], they would be much better off doing so,” Lo said. “If they aren’t able to borrow from a bank, then they shouldn’t resort to borrowing from these ‘alternative mortgage lenders’ because doing so will just get them into debt that will be very difficult to pay off.”