What Caused the Toronto Real Estate Crash of 2008?

When the Toronto real estate prices came crashing down in 2008 there were many people who were astounded that this kind of thing could happen in this day and age. However, there were many others who were not surprised by the events and had, indeed, been predicting that this very think would eventually happen.

The loss of the subprime market has been held as one of the leading causes of the real estate market crash. Sub-prime mortgages were approved at an amazing rate by all mortgage lenders. Such loans involved using lending practices that put the lenders in a higher risk category, such as lending more money to borrowers to buy real estate than they really could afford, offering deals on the amounts of down payment required and offering loans at lower than standard interest rates. As a result, many of the major lending institutions found themselves in a credit crunch with many of the borrowers unable to meet their payment obligations. Companies were forced to declare bankruptcy putting millions of people out of work and forcing the lenders to foreclose on the mortgaged real estate.

The crash of the sub-prime mortgage industry has been the focus of news reports for the past year in Toronto and elsewhere. While millions of Toronto homeowners have been affected, no one is quite certain as to the initial cause of this real estate downturn.

The Toronto real estate industry was a gold mine for investors in the past number of years. One could purchase a property, make a few renovations and resell it for a sizable profit. Even those with poor credit ratings could afford to purchase a home or condo in Toronto. This is because the restrictions on lending were more relaxed in an effort to entice more buyers into the real estate market. Lenders were able to make a killing by approving mortgages for those with bad credit by charging high rates of interest on the loan. The lenders believed that they would make a profit while the borrower was making the payments and if the time came when they had to foreclose, they would make an even larger profit on the resale with real estate prices continually rising.

The source of the funding used by lenders in order to offer these mortgages was varied. Due to low interest rates offered between banks, lenders were able to secure funding at a low rate of interest and then charge a higher rate when they approved mortgages for their customers. The real estate market remained stable and there was a boom in new real estate construction all over Toronto. Instead of the normal 20 or 25 year mortgages, consumers were taking out mortgages for 35 and 40 years in order to have manageable payments each month.

Toronto homeowners were taking on massive amounts of debt in order to own their own home and get out of the cycle of renting. The real estate market was healthy and everyone expected that it would continue to be a very profitable sector of the economy. It appears now that in hindsight such expectations were very unrealistic.
2005 and 2006 were boom years for the real estate sector. Lenders approved mortgages for virtually anyone that applied making it very lucrative for them financially. However, the start of problems occurred when the previously low interest rates offered to lenders started to rise and this had a negative effect in that their profits started to decrease dramatically in a short period of time. Low interest rates spur spending whereas high interest rates deter spending on real estate.

Up until the middle of 2006, there was an unprecedented demand for new housing and real estate construction. Builders could not keep up with the orders, often having a wait list of customers waiting for homes to be built. Some real estate was sold before construction even started. The second half of 2006 saw this demand for real estate gradually starting to decrease and it was about the same time that the first increase in loan defaults became apparent in the Toronto real estate industry.

In 2007, lenders started to encounter difficulty obtaining funding for the mortgages they wanted to approve for customers. Since there was less money available, those who wished to become homeowners were finding that the doors were starting to close on easy financing. Wary investors developed stricter guidelines for mortgage lenders which led to the lenders tightening their own lending guidelines.

With rising interest rates on the market, Toronto homeowners who had taken out adjustable rate mortgages were faced with impossible monthly payments when the adjustment occurred on their mortgages. They found that they were unable to meet the unusually high payments required to keep their accounts in good standing and because of the new regulations, they were unable to refinance for fixed rate mortgages. More and more homeowners were left with no choice but to default on the loans and the number of foreclosures reached massive proportions.