For the past four years, says Jon, he’s been waiting for houses to cheapen. “Renting, saving and investing,” he tells me, “with bated breath.”
Finally it was all too much. “As we stand on the precipice of historic housing highs,” he says with a flourish, “alas, the idea was hatched that we moved back in with Mom – after putting on an addition and renovating the place.” Late thirties, two screamers – it seemed like a good idea. After all, the old gal lives in a good hood, and it “would show the kids that family sticks together.”
But, adds Jon, there was “a nagging feeling prompting us to assess our sanity. Hence talking to you.”
That is probably a mistake, but let’s push on. Turns out Mom has $300,000 left owing on a place worth five hundred, and Jon would personally foot the $150,000 addition. “But what happens when Mom’s pension runs dry in ten years, or when she croaks and the other three siblings want their cut,” he asks? “Any equity we put in until then gets split? What provisions could be made in advance to avoid squabbles down the road regarding the inheritance? Or do we hold the course, forget the whole thing, and ship a case of depends and Purina anonymously? Can this end well?”
Jon needs to remember one of the GreaterFool cardinal rules: never invest in real estate with anyone you’re not sleeping with. That includes mothers. Your own, I mean.
The potential problems are legion. If Jon’s going to spend serious money renovating the house, he needs to be on title in order to protect that investment. But with Mom on a pension and a substantial mortgage outstanding, it looks like the house equity constitutes the bulk of her net worth. So, will the other three children come looking for their slice when she passes?
You bet they will, presuming Mom’s will divides her estate equally between the kids. So, Jon would not only inherit a $300,000 mortgage if he assumes title with her (and she lacks insurance), but he’d have to remortgage the place to suck out two-thirds of the remaining equity (including the addition he financed) in order to pay them off. Disaster.
How to avoid this? Don’t do it. In fact, Mom-with-the-$300,000-mortgage should sell and rent, since it would lower her overall living costs and give some cash to invest for an income stream she obviously needs. Hopefully she’ll live long enough to consume it all. However, if Jon truly loses his mind and goes into this unwise situation, he needs to ensure Mom’s will is rewritten to deal with the new reality. He should also pay the premiums on an insurance policy (on her life) large enough to handle the inheritances.
But the best strategy is to keep the baited breath, save, invest and rent. Because with every day that passes, we move closer to the event he has been waiting for. Most people don’t believe this, (which is why I have no friends) and a big report on debt in the last few days reinforced the popular meme.
Maybe you saw it. The Fraser Institute said there is no borrowing crisis. “Little evidence that Canadian households are being irresponsible in taking on new debt,” it said.
Really? With $1.3 trillion in mortgages and households owing more than at any point in history, with the IMF and the World Bank, all major ratings agencies and virtually every major economist – even the prime minister- warning about piggy borrowing habits, how can this be?
The think tankers make this argument: assets (mostly real estate) have risen 31% in the last five years, while debt (mostly mortgages) has increased “by just” 21%. So, whazza problem? Besides, the Fraser Institute says compared to other countries, like Norway, Switzerland and South Korea (seriously, I’m not making this up) our debt-to-income ratio don’t look so bad. (But compared to the country most like us, the US, it blows.)
Conclusion: “Canada doesn’t have that problem. Our banks have tighter lending standards and Canadians are clearly managing their debt levels responsibly with no evident strain to their incomes or balance sheets.”
Well, remember those people sitting in lawnchairs yesterday outside a sales centre in a GTA suburban field waiting to spend $2 million on a monster particle board house that increased in price $150,000 overnight? Those are the faces of debt. It is the intersection of greed and stupid. This is what risk is made of.
As Capital Economics points out, the think tankers took only mortgage interest into consideration (not debt repayment) when doing their report. They didn’t acknowledge the potential of a real estate correction, as is now gripping Alberta. And they reinforced the delusional belief interest rates can never rise.
The scariest part of this is believing that houses are more valuable because they cost more. In fact, real estate costs more because money costs less.
There is no intrinsic increase in shelter itself, just that cheap rates have allowed people to pile on epic debt and carry it for the same monthly fee. Say the economists: “While total net worth has risen by 141%, real estate has grown by 211%, contributing 55% to the overall gain in net worth. But with house prices now at record high levels relative to incomes, there’s obviously a greater than normal risk of a correction which, in turn, would hit net worth hard and, indirectly, negatively impact household spending. Since household spending represents more than half of the entire economy, these household balance sheet risks should be taken seriously.”
Jon should rent. His mom, too. Let the greater fools borrow. Just watch.