Analysis - Canada house appraisal tool seen skewing values
TORONTO (Reuters) - A Canadian database that allows mortgage lenders to appraise a property quickly before writing a loan may have overvalued homes in the country's sizzling housing markets and could raise the risk of a devastating U.S.-style crash.
Some experts worry it puts lenders and mortgage insurers in a vulnerable position should the hot housing markets of Toronto, Vancouver and other big cities experience a hard landing.
Fears that the housing market may be at a tipping point are intensifying. On Monday, data showed Canadian home sales fell by 15.1 percent in September compared with a year earlier, while Canadians' indebtedness hit 163.4 percent of their income, much higher than previously thought.
Documents obtained through an Access to Information request suggest some industry players are worried about the database, called Emili and operated by Canada Mortgage and Housing Corporation, a government-owned mortgage insurer.
Lenders use the system to gauge if a house is worth the price the buyer paid, and if not, they may decide to withhold the full value of the mortgage.
Emili uses a combination of sales figures from nearby homes, property assessment data and information about the property taken from its online house listing. It saves the lenders time and money because they do not need to send experts to appraise the value of an individual property.
That said, the system "has significant shortcomings," says one respondent quoted in the documents from the Office of the Superintendent of Financial Institutions (OSFI), Canada's federal banking regulator. The documents were compiled as part of a consultation process on mortgage underwriting practices.
By relying on data from surrounding properties, the system is prone to looking past specifics that could change the value of an individual property, critics say.
Perhaps more alarmingly, it also often uses information provided by the home's seller, such as property dimensions and condition of infrastructure such as heating systems, and online house listings can often exaggerate such information.
OSFI, which oversees CMHC, concedes automated appraisal systems can skew values to the upside, saying in the documents that "they are driven by the seller's listing, which often inflates the value of the home." The regulator also warns that lenders should not rely on just one appraisal method.
Emili, created in 1996, has come under scrutiny because of fears that Canada's hot housing market could implode like the U.S. property market did in 2007.
Canadian home prices fell a little during the worst of the U.S. crisis in 2008, but quickly regained their footing and have continued to push higher, underpinned by Canada's steady economy and rock-bottom interest rates.
However, prices are now dropping in the Vancouver market, and many fear the same fate awaits the country's largest real estate market, Toronto, where a forest of condominium construction cranes dot the waterfront raising the spectre of a supply glut.
"It's no secret for years now that within the industry there were doubts about Emili and its accuracy," said Finn Poschmann, vice president of research at the C.D. Howe Institute, a Canadian economic think-tank.
As Emili only comes in to play after a sale agreement, it is unlikely to push home prices higher, Poschmann said. But the system could result in buyers being approved for home equity-backed lines of credit at higher values than the house warrants.
To be sure, other appraisal systems have flaws, and falsely inflated property appraisals were one factor in the U.S. housing crisis. Licensed appraisers, often hired by mortgage brokers on behalf of homebuyers, were under pressure to inflate home values so buyers could qualify for the loans they needed, and that helped drive up overall prices
Canadian authorities have tightened rules on obtaining mortgages to avoid such risks, such as requiring borrowers take out mortgage insurance on any purchase on where the down payment is less than 20 percent.
But such precautions haven't stopped some from worrying that the flaws in the system could become an issue if the Canadian housing market runs into a worst-case scenario of rising interest rates and defaults.
In that situation, banks could find themselves holding collateral that is worth less than they thought.
"The problem's on the CMHC and the mortgage insurance side, because if you're talking about 5 percent down mortgages, then all of a sudden the error in the system starts creeping up," said Tsur Somerville, a real estate finance professor at University of British Columbia.
CMHC provides the bulk of Canadian mortgage insurance, while smaller competitors Genworth Financial Inc (GNW.N) and Canada Guaranty provide the rest.
CMHC said in a statement that Emili was just one tool used by underwriters and that the insurer "looks at the specific characteristics of the property in question and uses different information sources."
(Additional reporting by Andrea Hopkins; Editing by Frank McGurty and Janet Guttsman and Leslie Gevirtz)
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