The Canadian mortgage market used to be very simple. We had the big banks, credit unions, and trust companies.
However, almost 20 years ago, the Canadian government made three major changes to the Canadian mortgage industry. First, the government and CMHC put their weight behind Canadian mortgages by guaranteeing an insurance payout to lenders in the event that a borrower does not pay. Yes, the Canadian taxpayers are on the hook if CMHC goes under.
Second, Canada also began to allow lenders to pay for mortgage insurance for their borrowers, even though the insurance was not required. Borrowers would not know that their mortgage is insured, rather the lender would pay for, and insure the mortgage on the “back end” in order to make the mortgage less risky. I.E: if the borrower did not pay, the insurer would pay the lender (just as they would pay if the borrower had less than 20% down payment and was charged for insurance themselves).
And third, Canada allowed its lenders to bundle up their mortgages and sell them to investors. The securitization of mortgages (the process of taking the mortgages and transforming them into a sellable asset) allowed investors to purchase many mortgages at once, knowing there would be a specific return. The return here would be just less than the interest rate on the various mortgages (less because the lender has to make a little bit of money for creating the mortgage bundle or security).
Now, mortgage investors are looking at two things: investment return and mortgage risk. The lower the risk of an investment, the lower the return an investor may be willing to see. Because Canadian lenders can insure their mortgages against default (non-payment), investors are very keen on purchasing these mortgages. Thus, investors provide lenders with a lot of inexpensive money to lend out, which in turn, provided for better interest rates for borrowers.
As an aside, an example of investors may be one of Canada’s large banks, an American bank, pension funds, and/or other financial institutions.
The result was the emergence and major growth of mortgage finance companies, called wholesale lenders or monoline lenders.
Monoline lenders, encouraged by access to cheap capital, set up efficient mortgage underwriting (approval) operations and were able to provide flexible mortgage products and better-than-the-banks interest rates for their clients.
The overwhelming majority of wholesale lender mortgages are back-end insured by the lender, packaged up, and sold to investors.
What is interesting here is that wholesale lenders will insure mortgages transferred from one institution to another – something that banks do not do. This allows for better interest rates when renewing with a wholesale lender than if renewing with your current bank lender.
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