Paul’s buying a $1.3 million house in a sexy hood within 905 (not the one that blew up this week, amid hand-written notes of despair). “It’s actually a good deal,” he says bravely, thinking the property’s appreciated considerably since he did the deal a few months ago.
Well, he went to one of the big banks for a mortgage (the green one). The eight hundred grand he arranged came at a good rate – 2.4% – plus [email protected] threw in another $300,000. “Just for things you might need, or whatever.” That piece of the loan isn’t amortized, and can be taken with interest-only payments, also secured by the house. In other words, it’s a borrowing of 85% of the full value of the property, but still not considered a high-ratio loan. So no CMHC insurance.
That’s not all.
“She also offered me an amortization on the $800,000 portion of 30 or 35 years,” Paul reports. Going long would drop the monthly from more than $3,500 to less than three grand. “It was tempting.” But, of course, there’s a cost to lower payments. With a standard 25-am he’d owe $675,700 at the end of the term, and with a thirty-year am, $703,000 would remain – even after making $187,000 in payments.
Now, you may have thought Ottawa banned long-amortization mortgages. Once pegged at 40 years, they were chopped back to 25 by the same Harper government that goofed by extending them in the first place. But that was just for “high-ratio” mortgages – those where the purchaser has less than 20% to put down.
The Harperites, as you recall, also banned CMHC from insuring seven-figure houses which means Paul has to come up with at least a fifth of the purchase price. No problem there, because he’s selling elsewhere and moving up. But in this case the bank is offering him an 85% financing without requiring a CMHC insurance premium and also extending the forbidden fruit of a l-o-n-g amortization. The effect is twofold: monthly payments are less, so on his income he qualifies to borrow more.
There ya go. More evidence wealthy people get a better deal than poor ones. Just like investors paying half the tax on their financial asset income as workies do on their paycheques. But that’s not the point of this post, rather to confirm that real estate is also eating the rich.
Two years ago a minority of uninsured loans (on million+ properties or deals where buyers had more than 20% to put down) had amortizations of more than 25 years. Last year that climbed to 58%, and it’s currently estimated to be 63%. That means almost two-thirds of borrowers – mostly of expensive properties – are opting for loans giving them the lowest monthly payment, even when it means they slow debt repayment.
The Bank of Canada worries about this. It should. When ‘rich’ people buying ‘carriage trade’ homes struggle with their monthlies, it’s just more proof we’re all getting over-extended. In its latest Financial System Review, the bank said: “To help lower the large mortgage payments typical of higher loan-to-income ratios, an increasing proportion of uninsured mortgages have been amortized over more than 25 years. The resulting slower repayment of debt leads to a higher aggregate level of household indebtedness.”
And there’s more. As pointed out here a few times lately, more and more high-end homebuyers (properties over a million) are slipping into the Holy-Crap category (a technical term) of indebtedness. A majority in the GTA owe 450% or more of disposable income, and in YVR it’s four in ten. So, it’s not just the young and feckless who are borrowing beyond their means. The old and fecked are catching up fast.
So let’s put this in context. Five-year, fixed-rate mortgages have descended into bottom-feeding territory. Who ever thought 2.11% would be offered by mortgage brokers? After all, inflation is running perilously close to that, meaning this is akin to free money. At these levels, borrowers can trash home loans at a rate unknown a decade or even five years ago – if they keep amortization periods at 25 years or less. Instead, we’re seeing the opposite, as yesterday’s graph showed. The aggregate of debt is rising wildly, even as borrowing costs decline. So, imagine what happens when rates eventually turn.
Bigger loans and longer ams, meaning lower qualifying incomes, plus add-on lines of credit and higher debt ratios are the dirty secrets of the house-wealthy. When the tide goes out, the naked will be known.
In order to buy an average detached house in Vancouver with a super-sized 25% deposit, the average family would have to spend 119.5% of their gross income on carrying costs. Yes, that’s 20% more than a couple earns even before paying income tax, CPP, EI or making a company RRSP contribution. So, it’s likely 140% of what they net.
In Toronto, says RBC, the average SFD house requires 72% of gross income, or about 90% of net. It leaves basically zippo to live on. These numbers, the bank adds, have never been this high. Not even when mortgages cost 20%.
It’s a crisis, says the prime minister. So as a result we now have a federal task force studying what to do about this:
As you have been told here, a majority of buyers of million-dollar-plus houses in the GTA are now taking 30 or 35-year amortizations, in an attempt to keep monthly payments within their strained budgets. Four in ten (and six in ten in YVR) have debt equal to 450% or more of disposable income. These kinds of numbers have never previously existed.
Then there’s this. Mortgage debt in total has been hockey-sticking right along with house prices in Vancouver. Credit continues to expand even as the economy does not. The amount of borrowing is also at an historic level. And just look at the trend…
The reason people are borrowing their brains out is simple. They want to own more than they can afford to buy. The average weekly earnings this year are up just 0.4% from last year, while the inflation rate is 1.5%. In fact, average wages are lower now than they were at the end of 2015 – thanks to a crappy economy, a collapse in oil prices, decline of the dollar and Justin Bieber sucking off too much of the GDP.
This chart is a few years old, but I am sure you get the drift…
It probably doesn’t take an economist to tell you this is a recipe for potential disaster. Either people in general have to earn a lot more money, borrow a lot less of it, or quit spending $1.3 million on a house which doubled in value over the past decade of tepid growth and flowering angst. Any kind of economic shock would obviously cause chaos, but the danger extends beyond that. This is a house of cards likely to topple inwards from its own bloated weight. No asset goes up forever. All booms end badly. Every bubble bursts.
Unless, of course, this ain’t no bubble. What if it’s all normal, and God intended for Vancouverites to be enslaved and Torontonians to be gelded? If you believe that, you must be a mortgage broker. Like this honest guy just helping bankrupt people buy properties…
The Mortgage Professionals Canada has issued a fat report, authored by chief economist Will Dunning, saying no housing bubble exists in Canada and that it would be “tragic” for Ottawa to try and reduce prices by curtailing demand. “There is a risk that changes in policies of lenders or mortgage insurers that reduce access to mortgages could cause an unnecessary drop in housing demand and housing prices, and bring consequent economic damage,” the brokers say. “At this time, we are hearing calls for more changes to macro-prudential regulation. The proponents want to make mortgage finance more difficult to obtain. That will result in reduced housing activity and, thereby, slow the growth rate for mortgage indebtedness.”
Like that – slowing the rate of indebtedness – is bad thing. Certainly to the people who lend the money it is. But not to the nation or the economy as a whole.
Despite all of the above (which Will well knows), why’s there no bubble in Canada? Even when average families in major markets can no longer afford average homes, and house prices have soared uncontrollably as mortgage rates snaked lower?
Because, say the brokers, a bubble only happens when “expectations of price growth… are self-fulfilling.” In other words, people start buying houses because they think they’ll continue to go up, which breeds higher prices partly because of the higher prices they just paid. To Dunning, careening house values detached from the economy indicate everything is cool. So buzz off. “Housing bubbles do not exist in Canada… Price growth in Canada, even in Vancouver and Toronto, is still consistent with the economic fundamental of interest rates and affordability.”
There is it. The official position of an 11,000-member regulated organization made up of people who sit across the desk from hopeful buyers, whether young, unemployed, without savings, bankrupt, with horrible cash flow or poor credit, and give them money to buy what they cannot afford. Because houses always go up. No risk. Just gains. And, above all, there’s no bubble.
God help us.