Entries from May 2009 ↓

The doctor is IN. The first patient today in our moist coastal clinic is Alec.

Enter, my son.  Tell the doc where it hurts.

“My wife and I are 32 years old and own a house in Maple Ridge British Columbia.   We owe about $32,000 on this house and have about $8,000 on a line of credit.  Our mortgage is prime + .15 percent.  Both our cars are paid for and we do not have any other debt.  My wife and I bring in around a $100,000 a year between us.   My wife is itching to buy a second house; for around $500,000.  I do not think it is a good time to buy though. When we do buy we would like to rent out our existing house as rental income.  What do you think of this scenario?  What would you do if you were wearing our shoes?”

So, Alec, are you on drugs? Or just your wife?

I mean, really, the average house in Maple Ridge is worth $450,000, which means you probably have well over $400,000 in equity. At the same time, local sales are slow and prices stagnant, which means your rate of return on that whack of money is zero.

Your mortgage payments are ridiculously low, you have no debts (other than the LOC) and your two-income household (no kids mentioned) brings in $10oK. In case you didn’t notice you’re doing better than 90% of Canadians. So why do you want to screw it up?

First, think through this second house scenario. The only way you could buy a second $500,000 property is to heavily mortgage your existing place, raising $250,000 or so to put against the new one, which would still carry a mortgage of equal size. In other words, you have to rent out your existing home just to pay for the financing on it, plus property taxes and maintenance – for a net income of (at best) nothing. Then you’d have an equal financial load to carry on the second home. Trust me, this is not the way you achieved your existing net worth at age 32.

Worse, you’re taking on substantial debt when interest rates are at their lowest point ever, which means the cost of the financing will be going in only one direction. Conceivably, this could double your payments five years out. Even worse, you are flinging all your eggs into one basket with a headlong plunge into more real estate, at a time the long-term prospects for capital appreciation are as appealing as Michael Jackson.

In short, how could smart and successful people be so dumb?

If you want a trophy house, just admit it. Sell your existing place, trade up, and spend quality time stroking the granite and stainless. You’ll end up with a new $150,000 mortgage, which is a hell of a lot better than $500,000 in debt and two properties to worry about.

But if you’re asking the doc what to do to become financially independent, it would be to unlock some of the $400K you now have in equity (earning nothing) and put it to work. You can do that by selling and downsizing, by remortgaging and investing in stocks, commodities, funds or bonds (and thereby creating a tax-deductible mortgage), or through a HELOC used for the same purpose. Or, you can simply get a leverage loan based on your net worth, unsecured by your real estate.

But the last thing you should do is heed your wife.

Your prescription will be ready in a moment. She won’t feel a thing.

In the last few hours, this comment was left on the blog by a guy named Frank, location unknown:

I am out! Just sold my home to a young greaterfool couple . It was only a matter of time before we would of gone bankrupt. We made a huge mistake one and a half years ago buying , now our nightmare is over. Not sure how much we lost but at least we don’t have to file for bankruptcy. Do people see whats going on in the economy? we thought we were done and couldn’t believe there were more greaterfools out there. Advice for those looking to buy, don’t do it. Home owners are looking to jump out of that debt trap which will lead to bankruptcy. The first time in my life the media helped us by the non-stop propaganda of lies. How are those idiots able to get a loan in this really bad recession?

Shortly after I read Frank’s astute comment, I talked to a long-time buddy, who’s spent the last dozen years building up a blue-chip consulting engineering business. His wife’s had a glamour job in the entertainment sector, involving lots of trips with people we see on magazine covers.

“It’s tough out there,” he said. Corporations and governments have slashed their consultancy budgets to the bone. “Yeah, and Wendy lost her job.” There was some desperation in that voice. He asked me quizzically about the latest car sales (up a little) and real estate numbers (up considerably), saying how can the economy be getting better when virtually everyone I know over the age of 45 is either unemployed or terrified?

So I told him about this parallel universe which has formed within the last five weeks – the one inhabited by politicians, central bankers, realtors and our self-serving media. That cabal is trying everything it can to create a self-fulfilling prophecy, convincing consumers and homebuyers the economy is rebounding fast, that today’s prices are a bargain, and going into debt when interest rates are at rock bottom is a sweet move.

Is it working? You bet. Every day I field emails from disheartened young buyers who have just lost out on a bidding war. Realtors and bank economists are now saying a massive tidal wave of 36,000 new condos in Toronto will be easily absorbed – just months after this looked like a rolling disaster. Whole neighbourhoods in Vancouver and Edmonton are seeing frothy home values. And mortgage brokers everywhere, along with bank loans officers, are besieged with applications for refis.

All around us, Frank, people are streaming into new debt. Lines of credits, personal loans and especially mortgages are flying off the shelf. There is absolutely no doubt that Canadian households will owe more money at the end of 2009 than they did at the conclusion of 2008.

And so what?

So, it means we’ve learned diddly. It was just seven months ago we were all thinking about squirrel recipes, bank failures and places to flee when society ruptured. The great credit orgy of the last two decades was raining its retribution down after homeowners, Escalade owners, corporate execs, investors and governments who had borrowed and spent wildly. Real estate, profits, confidence and jobs were all hammered as a result.

Politicians everywhere have responded with massive spending of money they don’t have, while dropping interest rates to entice citizens to do exactly the same. And, Frank, they are. They have fallen for this, hook, line and (especially) sinker.  Supported by their revenue-starved friends in the media, they’ve successfully woven a narrative of recovery, growth and hope.

Sadly, though, it’s fiction. Nobody every borrowed their way into solvency. This is still going to end badly.

But thank God, eh Frank? She also created greater fools.