Entries from September 2009 ↓

They call it ‘jingle mail.’

That’s the sound an envelope full of keys makes as it hits a banker’s desk. In the US over the last four years, untold numbers of those envelopes have arrived as homeowners abandoned their real estate and surrendered their keys.

Why would they do that? In some cases because they could no longer make mortgage payments after losing a job or seeing interest rates soar. But in most cases, because they were underwater – a plunging real estate market had dropped the value of their homes to the point where they owed more than the places were worth.

So, why bother owning? Why make mortgage payments? Why pour more money down a housing sinkhole if you don’t have to? Why not walk?

After all US lenders have a weaker covenant than in Canada. If you welch on a mortgage, the bank must elect to chase you, or simply to take the house. In all but a few cases, they go for the keys.

Now, let’s talk about Canada.

The facts are simple enough: We’re in a housing bubble. Based on international measures of affordability, with the average home requiring more than 5 times the average income, Canadian real estate is currently “severely unaffordable.” Fact is, it’s more unaffordable here right now than US housing was when it collapsed. And this is with the lowest mortgage rates ever. Imagine what happens when 3% mortgages become 8% loans in five years.

Imagine what becomes of people buying today with 35-year mortgages and virtually nothing down if the housing market does the expected thing, and drops by 20%. Suddenly armies of newbie homeowners will be just like folks in Phoenix, Stockton or Dade – under water.

What happens if they have negative equity, can’t sell their homes for nearly enough to break even, and decide making payments on a mortgage bigger than their home is insanity? Will they walk? Fill Canada Post with jingling envelopes?

Lately this question’s been asked on this blog, with conflicting advice proffered, some it by lawyers who clearly got their degrees online from a welding academy in Tuvalu. Time for clarity.

In all of Canada but Alberta (figures), the lender has you by the shorts. Our mortgages are called “recourse” loans, which simply means the banker has full recourse to collect not only on the debt, but the costs of the debt. If you execute a standard mortgage document, and miss mortgage payments during the term, or fail to fully pay it off at the end of the term, or do not refinance it satisfactorily, then…

• The lender can legally gain title to the property, and sell it, and

• sue you for the difference between the mortgage amount and the sale proceeds, and

• sue you for costs, including all legal activity, real estate commissions and taxes, and

• if you cannot pay this amount, get a court order to garnishee your wages for the rest of your miserable life.

• And, by the way, you will get sued, even if you have little in assets and your mortgage was CMHC insured. The banks have whole floors of lawyers. Not pretty.

Of course, you can avoid this by declaring personal bankruptcy. In that case, the bank gets the house and you get a black mark that lasts for several years. It can mean no credit cards, no loans, no new mortgage, no new car, no running for the school board or political office, a big problem with credit checks, more difficulty finding almost any white collar job and even hassles renting.

Or, you can be an Albertan.

Albertan law is more akin to US law (they like George W., too). In that province mortgage lenders have less recourse, and the easiest course of action is to seize the property for non-payment of a mortgage. That, however, ain’t the end of it.

Even after the property is gone and sold, it is quite possible the lender will sue for a shortfall between the sale price and the loan amount. Arguments under Alberta law will likely overturn that, but only after you’ve burned through ten or twenty grand in litigation fees.

And (of course), don’t try going back to the same lender in the future for a new mortgage.

But, as you know, Alberta doesn’t matter (at least here). That’s because 90% of Canadians don’t live in the republic. So, recourse mortgages are what nine in ten of us must fear.

This matters intensely because I’d say about 10 out of 10 first-time homebuyers now gorging on cheap debt, getting caught in bidding wars and laying down their treasure for houses worth a fifth or a third less than market value, have no idea of the consequences. Most have never experienced a falling market, and spend more time finding the right jeans than the best mortgage. That’s no indictment of the young, since I’ve yet to meet a person of any age who’s actually read the loan agreement or the personal covenants it contains.

Some people argue our inability to walk away from a falling house is one reason we’ll never have a US-style real estate collapse.

Maybe so. But I’ll bet once our market correction takes hold, once negative equity hits the media, and once we remember prices don’t rise forever, the notion of inescapable debt will bite hard and long.

Hear Garth
Toronto – Sunday 2:30 pm, ‘Word on the Street’
Queen’s Park. Just show up.
Winnipeg – Tuesday 7pm. Financial Seminar
Reserve a seat here.

If this blog’s a microcosm of Canada, the country has issues. Upwardly mobile young brats taunt old Boomer farts. Alberta property lords dump on fragile Ontarians. Delusional Lower Mainlanders seek approval for their craven excesses. Bewildered Haligonians wonder what the hell everyone else is smoking.

Without much doubt, we’re in a transitional economy, trekking from near disaster a year ago to a destination unknown. Housing is up. Stocks have gained 35% since the Spring. Money is still on sale.

But at the same time, credit card debt has exploded. Unemployment’s up, not down. And, as I mentioned recently, two-thirds of people say they’d be screwed if one paycheque was one week late. In short, the bulls may be suffering from premature elation. Because consumer spending accounts for 60% of the economy, we ain’t there yet.

But I’ll have more to say on this tomorrow afternoon in Toronto and Tuesday night in Winnipeg.

Meanwhile, here’s a little follow-up to recent posts.

From the brat kid in Toronto making $200K a year with his girlfriend:

Thanks for posting a response to my email in your blog. It’s pretty funny seeing all the comments from your readers, and while some are extremely helpful and constructive, a lot or just jealous haters. Why would I make up a situation to get free advice? If they really must know, I am in the financial services industry and my fiancee is an optometrist (she’s actually only 25 since she skipped a grade, that’ll make your readers cringe even more). Seriously though, where do we get a place for $300K? We want something in the city or at least close to transit/highways but I guess we can’t have it all.

From some obvious smart guy in Burnaby:

You are doing a fine service to the citizens of this great nation. Because of you, I finally convinced my father to list his ‘box in the sky’ today.  We bought for $416,000 in 2005 in Burnaby, BC.  We listed it for $505,000 today.  Can you imagine, half a million dollars in Burnaby for a place with NO LAND!! We are hoping for a greater fool.

My fingers are crossed and am hoping that we can pay off the mortgage, pay the agents, pay the bank, and walk away…. AND NEVER LOOK BACK.

It was your insight that convinced me that I had to get my father out of the market.  Thank you Garth.  I will let you know when it sells! –Aggressively Listed in Burnaby

From the 40ish dink in Vancouver who didn’t like my advice:

After reading this and your repeated, completely out-of-context use of my “buy now or never” line, I have to wonder if you treated your constituents like this. I sincerely hope not.

The issue remains. You don’t offer much that is concrete, and persist in calling people fools, while encouraging others to do so as well.

You seem to skirt the issues, assuming only greed and speculation. I am not greedy, and I don’t think prices will go up. The only real question is, will they go down significantly? It’s looking increasingly “foolish,” at least here in Vancouver, to wager money, never mind your future, on this possibility.

From a guy some place in the country:

Garth, thanks so much for your voice of sanity.  I just bought your “Greater Fool” book and can’t wait to devour it! Question: Are mortgages in Canada “recourse” or “non-recourse”?  If house prices nose-dive, can home debtors just send the keys in and walk away, or will they have to declare bankruptcy?  One thing that is killing California is that housing loans are non-recourse, so people are just walking away, especially the $0 down crowd.  Could the same scenario play-out in Canada? Thanks and looking forward to your next post!

The answer tomorrow.