Canada's housing bubble – time to take away the punch bowl
Such post-recession excitement.
The price of an average Canadian home is up about 20% year-over-year. Even the mansions in the $7 million plus range are starting to move again. Credit Finance Minister Jim Flaherty for telling it like it is: the time has come to take away the punch bowl.
Did you know that Canada Mortgage & Housing Corp. can swing you a 35 year amortization mortgage with just 5% down on a new house?
Let’s consider the impact of this financial engineering, when it is combined with the lowest mortgage rates in my lifetime. In 1993, a 5 year mortgage would require an interest rate of about 7.25% at a local bank. Although it has been many years since I earned my “personal limits” at Canada’s First Bank, I believe your monthly P+I on a 1993-vintage $300,000 mortgage with a 25 year amortization would have been about $2,155. Assuming you put down 10%, you could swing a $330,000 home (inc. legal fees).
Today, what does $2,155/month get you in the world of 4% five year mortgages, 35 year amortizaton and 5% down? A house worth $512,837…and interest costs of $435k over the 35 year period (assuming the interest rate never changed).
Knock that 35 year amortization back to 1990s standards (25 year am), and, voila, you can only “afford” to buy a house worth $430,192.
A 35 year amortization schedule gets you 19% more spending power in the marketplace ($512.8k home) versus the 25 year style. And you just have to put up another $3,900 yourself; the price of a decent Plasma TV.
What a surprise…the price of an average home is up 20% year-over-year.
In a November report, the Canadian Association of Accredited Mortgage Professionals found 18 per cent of mortgages were amortized over more than 25 years – a gain of 100 per cent in two years. (Hat Tip Globe and Mail
That 18% equals $82.8 billion of a $460 billion chartered bank mortgage book; which means that more than $41 billion of mortgages have been added in the past two years with a 30-35 year amortization schedule. No wonder prices are up so dramatically.
Canadians shook their heads at former Federal Reserve Chairman Alan Greenspan when he refused to accept any blame for fueling the U.S. housing meltdown. Fortunately, we’ve learned from their mistakes.
Right? Not so fast.
CIBC World Markets economist Benjamin Tal warned Minister Flaherty via the DTM that “any change to mortgage regulations is potentially dangerous…because the government could ‘overshoot’ its goal.” (Economist Tal works for one of Canada’s largest beneficiaries of CMHC mortgage policies.)
Five years from now, if your 35 year am mortgage comes due at even a cheap 5.5% renewal rate, that 95% mortgage on the $512.8k home will cost you an extra ~$410 per month in (post income tax) payments. That represents an additional $9,122 of your pre tax income five years from now.
If you could only save $24,000 to put into the downpayment at the outset of home ownership, how easy is it going to be to part with the additional $9,122 for your pre tax income five years from now?
Time for Minister Flaherty to take away the punch bowl.
MRM
Mark, I really have a tough time when inflammatory words like "bubble" are used to describe the Canadian housing market.
Our variable mortgages are nothing like American ARMs. Our 35-year am periods are nothing like American zero and negative am mortgages that fuelled unsustainable valuations. Our interest payments are not tax-deductable.
Real estate is cheap in Toronto compared to other global cities. A professional couple can still buy a house in Leslieville or Trinity-Bellwoods for around 3.0-3.5x income (150K income/$450-525K house) without resorting to an am period beyond 25 years. As long as there are professionals in Toronto, there will be demand.
Just out of business school we purchased a modest rowhosue in downtown east. I can walk to Bay St in under 25 minutes and our mortgage is "normal" (25y am, fixed at c.5%, c.75% LTV). I can’t think of another global financial hub where an early career guy like myself could easily afford real estate in the city centre.
Mark,
Great post. Every Canadian blogger that I regularly follow is commenting on the BoC/FM comment, but only you have put this right perspective with regards to what this means for ‘Pre-tax’ perspective. This mirrors my thoughts and advice to my friends and colleagues on the topic.
I cannot understand how many of my very educated colleagues(who are financial bankers) don’t factor this issue in their own real-estate investments.
It is so easy when the cost is broken down into a per-month basis to reduce the $$ impact. For example, $50/mth cell phone, $25/mth security monitoring, etc and using “oh, I can afford that!” justification without paying attention to what it really costs on an Annual basis and let alone what this means on a pre-tax income level.
I am ‘in the market’ for a house since I sold my place earlier this year, but despite having the possibly one of the best credit (Zero Debt, >150K income, stable job)I cant stomach the current housing prices that sellers are demanding and getting. This past summer I saw many families bidding up the house prices using the same justification of “$20 per month of high mortgage payment on that extra 10K- I can afford that”.
I guess I will happily be renting for some more time!
Exactly…the pre-tax perspective is critical to getting a true read on the numbers. Thanks and Merry Christmas all.
Just so you know – the CMHC does not issue mortgages nor does it set the minimum down payment requirements. CMHC provides insures mortgages with less than 20% down.
Thanks for stopping by our site, Pedro
I think these facts are well understood.
Cheers
MRM