What is a Subprime Mortgage?

A subprime mortgage is a financing option for home buyers who don’t meet the typical mortgage approval requirements set by traditional banks and credit unions.

Many Canadians consider subprime mortgages to be taboo, especially after the subprime mortgage crisis in the United States. But like many financial products, subprime mortgages have pros and cons to consider.

How subprime mortgages work

When a borrower doesn’t meet the qualifications to be approved for a mortgage loan with one of Canada’s chartered banks (referred to as A lenders), it can be disheartening.

Mortgage applications may be rejected because the borrower’s credit score doesn’t meet the minimum for a mortgage, or their income is difficult to verify (as it is for seasonal workers or individuals who are self-employed). These loan applications are considered less than ideal, or subprime.

In this situation, the borrower can either pause their home buying endeavor and spend time building a ‘prime’ financial profile, or seek out an alternative lender (referred to as a B lender) that is willing to lend them the money for a mortgage.

Since borrowers who cannot qualify with A lenders are, at least statistically, deemed to be a higher risk, the subprime mortgages offered by B lenders often come with significantly higher interest rates and closing costs.

Today, it is believed that nearly 12% of Canadians have a subprime mortgage.

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Can you still get a subprime mortgage in Canada?

Yes. B lenders have more flexibility than Canada’s chartered banks and recognize that just because an individual doesn’t necessarily have a good credit score, or a traditional job, doesn’t mean that they unable to handle a mortgage.

Qualifying for a subprime mortgage

While subprime mortgages do offer more flexibility, there are still certain qualification requirements. Depending on the lender, this may include:

Personal identification and proof of residency, such as passport or SIN number.
Pay stubs or other valid proof of income and employment history.
Bank statements.
Tax returns, T4 slips or notices of assessment.
A minimum down payment, sometimes as high as 20%.

Pros and cons of subprime mortgages

Mortgage approval requirements, like the stress test, exist to protect both borrowers and lenders. Borrowers who can’t meet these requirements are more likely to have trouble making their mortgage payments at some point.

However, for those with sufficient assets despite their low credit score or non-traditional employment, subprime mortgages can be a way to buy a home sooner.

Pros:

Allows certain individuals to buy a home without waiting until they qualify for a prime loan.
Easier to get approved.
May help you rebuild your credit.

Cons:

Higher mortgage interest rates.
Higher closing fees and associated costs.
May be limited to shorter terms than prime mortgages.

What was the subprime mortgage crisis?

In the early 2000s, 20% of the mortgages in the United States were subprime mortgages.

Many of these subprime mortgages were part of a financial product called ‘mortgage-backed securities.’ At the time, these securities offered investors high returns, higher than any government bonds. So mortgage-backed securities quickly gained popularity which, in turn, made it easier for subprime borrowers to get mortgages.

In addition to low inventory and rapidly rising home prices, excessive subprime lending helped create a precarious situation known as a housing bubble.

In 2006, the U.S. housing bubble collapsed. Home prices dropped dramatically and it became incredibly difficult for borrowers to refinance subprime loans with high or adjustable interest rates. People defaulted on their mortgages but their homes were no longer worth the value of the outstanding loans. In turn, this caused the mortgage-backed securities to lose most of their value.

This set of events was the start of a massive economic downturn in the U.S. that became the global financial crisis of 2007 and 2008.