Up to our necks in debt

There are increasing indications that our reputation of being a financially conservative in Canada is more myth than reality.  As a group, we’re taking on more debt than ever before and finding ourselves with less of a personal safety net should the economy take a dive.  Since 2001 the number of people over 60 that still have a mortgage has been steadily increasing, and the mortgages that we all hold are of more and more exotic varieties.  From todays Vancouver Province: Why we’re up to our necks in debt.

A rash of recent reports paint a scary picture of Canadians as spending like drunken sailors, leading to the prickly question of whether we should be forced to save money.

A Statistics Canada study showed Canadians are finding themselves with two mortgages and deeper in debt than at any time in their lives. They are increasingly house poor, and with housing values sliding, they often owe more on their properties than they’re worth.

The StatsCan study came out at the same time that the Office of the Superintendent of Bankruptcy Canada reported that personal bankruptcies reached their highest level in more than four years during April, up 19.3 per cent over the previous month and 18.3 per cent over the previous April.

And things will only get worse if recent numbers showing a gross domestic product decline during the last quarter continue, signalling an economic downturn, and if unemployment rates should start to rise.

As it is, mortgage payments make up 37 per cent of average household spending in 2007, up from 32 per cent a year earlier.

And those mortgages are getting more ‘interesting’.  The common refrain that the Canadian housing market is not as vulnerable to downturn as the US market  because we don’t have ‘sub-prime’ mortgages is only part-true.  What we do have is an mortgage insurance market that was liberalized in 2006 and has dramatically changed the landscape in the last few years with the introduction of zero-down, 40 year terms and adjustable ‘teaser’ rate mortgages:

With interest rates dropping, consumers might consider a front-loaded variable- rate mortgage.  This option gives you a larger-than-normal discount from the prime interest rate for an initial period, say six months, before you decide whether to lock into a fixed rate.

Longer amortization periods, now up to 40 years, also are new.  Holt estimates longer-term mortgages now account for three quarters of monthly insured purchase applications in Canada, with 40-year products accounting for half of that.

So will following the US lead into the area of ‘exotic’ mortgages lead to a similar result?  Only time will tell, but it is interesting to see that this topic seems to be getting more attention within the government.  That first article had this bit of info that was new to me:

Finance Minister Jim Flaherty recently suggested it might be wise to outlaw 40-year mortgages.

With up to a third of new mortgage applications opting for the longest term, removing that option could have a dramatic impact on our housing market at a time when it appears to be already slowing due to affordability concerns.

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observer
observer
12 years ago

Jesse: Point taken, inflation of prices doesn't necessarily equate inflation of wages.

jesse
jesse
12 years ago

"Of course another possiblity is that investors are betting that rents will rise…

There are indeed signs that inflation is picking up.

For inflation to be translated to rent inflation, wages need to rise as well or people just densify to make it affordable. As an example from a specific profession, Vancouver area Realtors on average are earning 25% less commissions this year than last. Public sector workers have wage increases negotiated at 2-3% per year. Hardly inflationary. I'll believe stagflation when I see paycheques rise otherwise I'll just reduce my spending in other areas to compensate for goods inflation. I'm sure most Canadians are doing the same or maybe just going into debt.

observer
observer
12 years ago

Sorry everyone for the duplicate post, my browser froze. Also, I meant price/earnings is at all time high.

observer
observer
12 years ago

Dave: Yes, I think in the event of a prolonged downturn or stagnation, there is also the possibility that it would make sense for some to buy rather than to rent, depending on one's financial and the economic circumstances. But my point was that it would depend on a lot on the individual's situations, and it must be the case that there would be a balance between those for which it makes sense to buy and those for which it does not make sense to buy, otherwise if one camp were to greatly outnumber the other, the market would not be in prolonged stagnation and would start tip either way. One point which hasn't been raised explicitly is that the criterion for deciding whether to buy or rent depends somewhat on whether one is buying to live in or buying… Read more »

observer
observer
12 years ago

Dave: Yes, I think in the event of a prolonged downturn or stagnation, there is also the possibility that it would make sense for some to buy rather than to rent, depending on one's financial and the economic circumstances. But my point was that it would depend on a lot on the individual's situations, and it must be the case that there would be a balance between those for which it makes sense to buy and those for which it does not make sense to buy, otherwise if one camp were to greatly outnumber the other, the market would not be in prolonged stagnation and would start tip either way. One point which hasn't been raised explicitly is that the criterion for deciding whether to buy or rent depends somewhat on whether one is buying to live in or buying… Read more »

Drachen
Drachen
12 years ago

Jesse

Well if someone were to attempt to use that explanation then they really also owe an explanation of why purchasers were wrong about fundamental value then and they're right now. An explanation of how this realization could come about in such an incremental fashion would help too.

jesse
jesse
12 years ago

"explain how prices can triple without any real fundamental change in the market?"

That's easy: prices were significantly undervalued before. Nobody realised it until just a few years ago. Besides, prices are forward looking and the future is looking pretty good. Future's so bright, I gotta wear rose-coloured shades.

jesse
jesse
12 years ago

"it is also possible prices will continue to rise. What if they go up another 5 to 10% and then drop an equivalent amount?" Good luck with that. It's possible but unlikely to say the least. Don't say you didn't get the memo ;). Anyways if prices went up X% and fell back to today's values a renter who is paying less in rent than the interest/taxes/maintenance for owning the same property is still further ahead. "I have yet to hear anybody say they are holding out to buy in Burnaby, North Van, Coquitlam or Richmond. The reason for that is because those places are still affordable." Once again you miss the big picture. Lump everyone's incomes into a giant pot and lump the appraised prices of residential properties into another pot. The income pot cannot carry the property pot.… Read more »

Drachen
Drachen
12 years ago

Dave "Only 40 years? That covers quite a few economic cycles within the same market (i.e. apples and apples). Unless you subscribe to long wave theory (e.g. Kondratiev), then I think it is a solid time period to use." Wow, you really don't pay attention do you? I've said a half dozen times already to you that I believe the bump in the '90s was a feature of our current mega bubble. Certainly the market has been abnormal since the late '80s. I know your type always wants to believe Vancouver is "different", although nobody has really explained why it's different and you certainly seem happy to use other cities as proxies when you think it fits your argument. The fact is bubbles have been happening for hundreds of years and the result is always the same. Prices drop to… Read more »

ReductiMat
12 years ago

Dave, don't feel bad for me on missing out. I'm saving roughly $6,000 a month renting versus buying the same place.

I have saved the difference and have done far better investing that sum than if I'd bought the place outright.

My position is that we don't have a strong enough economy to support $5,000 dollar rental pricing now, nor will we in ten years. $9,500 a month? I'll give it a reasonable chance in twenty five years. (This is for 1,200-1,400 sq. ft. prime Yaletown).

Nor do I think we'll see suites selling for $2,000 a square foot for standard floor plate, 1,200 sq. ft. suites within fifteen years.

With those assumptions, I'll be just fine renting in perpetuity, thank you.

Digi
Digi
12 years ago

What if they go up another 5 to 10% and then drop an equivalent amount? Possible, but not very likely. Ok lets say they did, If I'm looking at it as an investment it still an extremely poor one. Transaction costs are what, around 6%? So after that rise and drop I'd be down about 6% IF I bought with 100% cash down. Thats ignoring the opportunity cost of that cash. Lets say it takes two years for your imagined rise and fall. In that time the difference between what I save on rent vs. purchasing costs is currently around $2k per month. That adds up to almost $50K that can go into better investments than a stagnating (more likely dropping) real estate market. If I was a gambler (you'd have to be to buy in Vancouver right now) I… Read more »

Dave
12 years ago

Ha ha… thanks for reinforcing my stereotype Warren before I got the post off.

Dave
12 years ago

Only 40 years? That covers quite a few economic cycles within the same market (i.e. apples and apples).

Unless you subscribe to long wave theory (e.g. Kondratiev), then I think it is a solid time period to use.

Dave
12 years ago

Digi, it is also possible prices will continue to rise. What if they go up another 5 to 10% and then drop an equivalent amount? So, much for you $77k savings. I heard a lot of people say the same thing all the way up in the bull market… ‘I’ll wait until it corrects a bit and then buy’. Unfortunately, a lot of people missed out. Reductimat, I don’t know how far out of the money those buyers are. Were they just new to the workforce a few years ago and now have higher income and more stability? Or are they mostly people in a similar economic circumstance as they were before? I think there are probably more people in the first camp. The people in the second camp are probably always within the 30% that never buy real estate… Read more »

Drachen
Drachen
12 years ago

Dave

"The pattern seems to be flat prices for 6 to 7 years and then another bull market."

Would you stop looking at just the Vancouver graph? It only goes back 40 years and has only 2 or 3 features on it from which you're drawing conclusions. Do you realize how utterly stupid that is?

Warren
Warren
12 years ago

ReductiMat,

I'm in an almost identical situation, looking for prime Yaletown. As for $50k families, it doesn't sound like much, but you and I are in lets say the top 20% of earners, looking for RE in the top 5% of cost, in terms of the area. Its all relative.

ReductiMat
12 years ago

Then I guess the question is, how far 'out of the money' are the first time buyers. I'm guessing from the outset my inclination is much higher than yours.

My wife and I make a lot of money relative to the median or average. I have no idea how a family can survive here on $50k a year. We'll likely be buying when prices in prime-Yaletown hit $300/$400 a sq. foot or never. Whichever happens first.

Digi
Digi
12 years ago

As before, I think a person should buy when it makes sense to them.

I Agree, but your own estimate of a "10 to 15% drop" would be pretty dramatic at todays price levels. The lowest end 10% drop represents savings of more than $77,000 at todays benchmark house price.

As also pointed out, prices usually drop and then stagnate for years, so no real rush trying to 'time the bottom'.

For me personally, $77k is worth waiting for.

Dave
12 years ago

Dave, would you agree that the number of first time buyers that can afford to buy at this price point are at its lowest in say the past fifty years?

Yes, they have significantly dropped in the last few years.

I think it will provide some buffer on the downside because many of those people will want to enter after only a moderate price correction.

The Van Man
The Van Man
12 years ago

Dave, Unfortunately, I still can not locate an extensive HPI index for the GVRD region like those published by the OFHEO. With the Americans, you can actually see this information.. In Washington state, starting with the index of 100 from the 1980, they went through a similar rise and fall in their real estate, but during a span of some 20 years, to the year 2000, their index never had gotten past 300. Just 278.84. But from the year 2000 to 2008, it went from 278.84 to a high of 512.54 in 2007. It has dropped since to 510 in 2008. It took 20 years to get a more than double in the HPI, but it took only 8 years to not only quadruple but, I don't even have words for that. California is even more silly at 600+. In… Read more »

The Van Man
The Van Man
12 years ago

Dave, the HPI is a broad measure of the movement of single-family house prices. The HPI is a weighted, repeat-sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties. This information is obtained by reviewing repeat mortgage transactions on single-family properties whose mortgages have been purchased or securitized by Fannie Mae or Freddie Mac since January 1975. The HPI serves as a timely, accurate indicator of house price trends at various geographic levels. Because of the breadth of the sample, it provides more information than is available in other house price indexes. It also provides housing economists with an improved analytical tool that is useful for estimating changes in the rates of mortgage defaults, prepayments and housing affordability in specific geographic areas. The HPI includes house price figures for the nine Census… Read more »

“Road To Hell&
12 years ago

Chris Rea "Road To Hell" Live on Letterman

http://www.youtube.com/watch?v=rOimUM_sA0Q

“And all the roads jam up with credit

and there’s nothing you can do

It’s all just bits of paper flying away from you.

Look out world, take a good look what goes down here.

You must learn this lesson fast and learn it well.

This ain’t no upwardly mobile freeway

Oh no

this is the road

this is the road

this is the road to hell”

_______________________

ReductiMat
12 years ago

Dave, would you agree that the number of first time buyers that can afford to buy at this price point are at its lowest in say the past fifty years?

Dave
12 years ago

Observer, I think that is a valid observation and a reasonable expectation. The 1980 run-up was short and steep, which produced a similar fall (i.e. fast and deep). The 1995 run-up was slow and long and the correction was minor in magnitude but took longer to play out. It also obviously depends on the trigger. For example, a major recession would knock values down more quickly than a slight economic downturn. The pattern seems to be flat prices for 6 to 7 years and then another bull market. As before, I think a person should buy when it makes sense to them. Trying to time the market isn't worth doing. If you can afford to buy, plan to own for at least 5 years and find a product you want, then by all means, take the plunge. If I knew… Read more »

observer
observer
12 years ago

Dave: regarding your observation that downturns typically give up about 12-18 months gains going backwards from the peak: Might it be possible that the longer the run up to the peak the longer the clock is turned back, which might explain why the downturn in 1995 turned the clock back more than previous downturns, which were following short run ups. Another issue is how long the downturn takes to bottom out, which is the more relevant point I think in one's decision to rent or buy. After the 1995 downturn, it took until 2001 for prices to start appreciating again. If rents and cost of living were low during that period, it might not have made sense to buy depending on one's financial and economic circumstances, and indeed be worth sitting out for more than 12-18 months because the downturn… Read more »