Subprime lending in Alberta: Truths and Myths

What is the Subprime Market in Alberta

The Subprime Market made the national news in the US and has continued to be a weekly headline. A subprime market is one in where high lending rates are offered to borrowers with lower credit quality. These lenders borrow from the subprime markets because the main banking institutions will generally not lend to these types of investors. The Alberta Subprime Market does exist but not in the same scope as we have seen in the US. The hot Alberta real estate market, especially in areas such as Edmonton, Calgary, Fort McMurray, and Grand Prairie have led investors to borrow like there is no tomorrow. Everyone just wants to be in the real estate market of Alberta and the prices seem to keep climbing. With the price of oil rising to meteoric heights, the subprime market was also lending at meteoric rates with investors leading the way in borrowing from these non-traditional lenders. While the interest rates given by the main banks such as Royal Bank, CIBC, and TD Canada Trust remains at historic lows of 5% on a 5 year fixed rate mortgage, some subprime lenders were writing new mortgages that ranged from 7% to 20%. There have even been cases where investors who needed bridge financing to close on a deal would borrow from these second tier lenders at rates above 30%.

Foreclosures in Alberta as a result of Subprime Lending

Foreclosures in Alberta have seen a dramatic rise in the last 12 months. The year of 2008 has seen the foreclosure rate jump more than 50% with the lawyers working overtime to handle the workload of Foreclosures in Alberta. How can the rate jump so high? It is a direct result of subprime lending in Alberta and specifically in real estate heated markets such as Edmonton and Calgary. The subprime lending has allowed investors to over leverage their financial position and put themselves in an impossible position to maintain their properties. Once the ability to pay the mortgage is not met, these investors desperately try to liquidate their properties in a falling Edmonton and Calgary real estate market. The result is that many homes do not get sold, mortgages do not get paid and the foreclosures start increasing in the double digits. However, put into perspective, the foreclosure rate in Alberta, especially Edmonton and Calgary have been very low. Even with a tripling of the foreclosures in Alberta due to sub prime lending, the actual amount of Edmonton foreclosures is still small. We do not see a subprime crisis the equivalent of the US in Alberta or Canada. Even our subprime lenders are more careful than their US counterpart in giving out their hard earned cash. However we should expect to see foreclosures in Alberta to remain at historic highs for at least another two years while overly optimistic investors untie themselves from the poor investment decisions they have made.

Predictions for Subprime lending in Alberta

We predict that the subprime lending in Alberta will be reduced to normal levels for 2009 and 2010. Lenders such as HomeTrust, Resmor, and some private money lenders are just going to be careful by reducing their risk in a declining Alberta real estate market. Faced with falling real estate prices, the subprime lending activity in Alberta will become even below average over the next 12 months. You also got to know that the subprime lenders themselves are suddenly short of capital and must be conservative in their own portfolios or else face similar fates as the clients whom they lend to. When the economy is not doing well and jobs are not abundant the ability for investors to pay their mortgages will also decline. In a falling economic climate, sub prime lending is going to be placed at a low priority and it will be back to the basics of borrow what you can afford.

RRSP can be use as a tool to invest in Edmonton, Alberta real estate

It’s true that you can also use RSP to as an investment tool to invest in Edmonton properties. I’ll look at the benefits of how to do this in a series of upcoming articles and the best ways to tap into this form of investing versus investing in the traditional stuff such as mutual funds, GIC, stocks, etc.

What is a RRSP?

Investing in Alberta real estate with RSP is easy once you understand the basic. Let first look at what is a RRSP. RRSP is Registered Retirement Savings Plan and is one of the few tax benefits that are still available to individual Canadian taxpayers. I called this a tax benefit because you invest in RRSP with before taxes dollars. This is done by using a special investment account that is registered with CRA (Canada Revenue Agency). The amount invested into RRSP is based on before taxes dollars and allows you at the same time to also reduce your taxes for that year based on the amount that you contributed. This amount is calculated by CRA and can be found in your last year taxes return. If you have not contributed before or have not contributed to your maximum you therefore, have an unused contribution room. In any given year you are entitle to contribute to the maximum that you can afford and reduces your taxes at the same time. You might also borrow money to invest in RSP as well up to your annual contribution limit.

Annual Contribution Limits for RRSPs for your 2008 Alberta’s taxes Return

The maximum one can contribute in a year is called the “RSP deduction limit.” It is also known as the “annual contribution room” or “deduction room.” Your RRSP deduction limit is found on your Notice of Assessment or Notice of Reassessment from CRA. For example your 2008 limit would be on your 2007 Notice of Assessment. The annual limits in a nutshell are as follows:

Annual Contribution Limits
Year RRSPs
2007 $19,000
2008 $20,000
2009 $21,000
2010 $22,000

The Canadian government allow us taxpayer to deduct for example, in this case in your 2008 return $20,000 from your “earned income”. If this number is higher in your 2007 Notice it just mean that you have not contributed to your maximum RSP deduction room from your other previous years and this extra cap room can be use in your 2008 to help you save some money when you do your filings for your Alberta’s tax return by the April 30th deadline.

Why is the Canadian government so generous?

You might asked why is our Canadian government being so generous and giving us a tax break if we invest with them by buying RRSP? This is because the government know that the more people put away the less they will have to pay us down the road when we retired. Also the government might not have enough funding to pay everyone if we all decided to calculate CPP or Canadian pension plan when we retired. Depending on when you retired this money might not be so available by the time you retired as it might be used up by others such as the baby boomers when they retire over the next 10 to 15 years. This is especially the case if you’re just currently entering the workforce. And this is more likely so as Edmontonians have such a young workforce! To give us more incentive the Canadians government have long came up with a plan to allow us to save taxes and at the same time save for our future. This to them is a win-win philosophy and that is why there is always such a big push to put money into RSP around the February 28th taxes deadline times.

An example of Tax Savings using RSPs

For most Canadians investing in RRSPs is an excellent ways to save money for their future rather they retired at age 65 or earlier. Lets use a simple example here of how substantial this taxes savings can be for you in your next 2008 Alberta tax returns. Suppose you are one of those hard working Albertans and make over $100,000 a year and decide to contribute $20,000 to your RSP this year.

Earned Income - $100,000
Less RSSP contribution - (20,000)
New Earned Income or Taxable Income - $80,000

Providing this is your only deduction for your 2008 Alberta’s filing this year, this can equate to a tax savings of $7,800 just base on your contributing your maximum RRSP for 2008. Here is a simple