Entries from September 2009 ↓

Wasting away


Not a day goes by here without new arguments why interest rates won’t rise.

They go like this: The weather’s been good since last winter ended. People are enjoying it. They play and prosper in the sun. If the snows come it will be bad. We are not ready. We will suffer. Therefore the government will not allow it to be so.

Other variations, too. Like pointing to Japan where rates have stayed low for two decades. Or claiming central banks will print money, buy all the bonds, and keep rates low. Or the simple argument (above) that because Canadians have pigged out on cheap mortgages, saved nothing, bought McMansions on credit and would be completely screwed if mortgage rates went up, that the feds wouldn’t possible do such an evil thing.

Of course they will. And if they don’t, the bond market will. And I’m tired of telling you why.

Suffice to say this: Anyone not preparing now, is a fool. The kids camped out in front of Mattamy Homes in Milton, as the guys inside typed up new price lists (they added $10,000 on the weekend), are greater fools. Those who think the Bank of Canada can stem what the Government of Canada is doing  ($55,900,000,000 in new debt this year) are the greatest fools.

Like I said, this topic is boring me. Look outside. Damn, today the rain was almost sleet.

Hi Mr. Turner.  I read your blog daily, read your books etc.  Here’s my story, we decided about 1.5 years ago not to be “Fools” and stayed in our current home.  (We reside in a small rural town Northwest of Kitchener-Waterloo)  In the meantime our mortgage expired and we elected to take out a HELOC (TD Canada Trust).  We owe about $65000 on a home that is valued at $200K, this has worked well for the past 1.5 years however my concern is that TD has annouced a rate increase (As per your blog and I confimed this with TD) for the HELOC effective later this year, how many more rate increases are coming?  This is now, what’s next etc?

Any suggestions on how to insulate ourselves from future rate increases?  Lock it into a mortgage again for the 5 year term etc? Appreciate any advice! – Dave

This is a small taste of what’s to come, Davo. That 1% hike in the bank’s LOC arrives because it;s now originating that money in the bond market. So, despite the fact the Bank of Canada rate did not move, your loan rate increased by 44%. Coming will be similar increases in fixed and variable mortgage costs.

Hardest hit will be new buyers with 35-year amortizations and VRMs, since each hike in overall mortgage costs will end up adding to the principle amounts (virtually no equity is paid monthly on long amortizations and the existing monthly will not cover added interest charges). This will have the effect of dampening the real estate market, which around K-W is already kinda soggy.

As for your loan, remember it is purely a demand borrowing. You have zero protection against further increases. So, why not lock in now to a fixed mortgage rate? But do it right.

Here’s a radical suggestion: Get a conventional five-year closed rate home loan at the current rate of 5.5% (relax – that will look cheap within three years). Then ask for a five-year amortization. The monthly will be $1,200, and you will have you mortgage totally and completely paid off in just 60 months. The total amount of interest (included in the monthly payout) will be just over $9,000. There are other ways of doing this, but with a mortgage obligation the bank supplies the will power.

Compare that with your HELOC at the new rate of 3.25%, where five years of interest-only payments would be $10,562, and then you’d still owe $65,000 – and  be looking for a new mortgage at 8%.

Suck it up, Dave. Gird those loins. Head into the storm like a man.

We’re right behind you. Soon as we finish the drinks.

Related: Deflation threatens to eat Japan



William Stratas photo

SRO in T.O. on Sunday as Garth spoke.
He's in Winnipeg tomorrow. Reserve a seat here.

Are houses over-valued? How do you know?

Valuation has always been half scientific, half subjective. Whether it’s an ounce of gold at $1,000 US, or a share in RIM at $75 after Friday’s plunge – how do you know if something is fairly priced? Obviously millions of people got it wrong when they lost billions on dot.coms. The stocks were popular, wildly in demand, shooting higher – yet collapsed when investors saw they were fads, not businesses.

Or look at Nortel. Or GM. Or condos in New Smyrna Beach. Or a barrel of oil. Or a shack in North Van. At what point does an asset pose real intrinsic value, and where does it constitute a waiting disaster?

Since houses are primarily consumer products bought overwhelmingly by families for their own use, a worthy measure is tracking how much average income it takes, per city, to purchase the average house. This measure is a valid one since it factors in the intensely local nature of real estate markets, and also allows for geographical and regional differences in income.

In fact, it’s a measure which is used internationally, and forms the basis of a landmark report issued by Demographia last year contrasting housing in Canada, the US, Britain, Ireland, New Zealand and Australia. Simply, divide the average house costs in an area by the average household income to arrive at a factor.

According to Demographia, here are the benchmarks:

  • Affordable – 3 times income, or less
  • Moderately unaffordable – 3.1 to 4
  • Seriously unaffordable – 4.1 to 5
  • Severely unaffordable – 5.1 and over

So, how are we doing? How about in cities like Halifax (family income $75,500), Toronto ($71,000), Winnipeg ($66,400) or Vancouver ($68,700)?

Well, Halifax wins the affordability challenge with a rating of 3.2. Winnipeg is next at 3.44 – moderately unaffordable. Toronto staggers in at 5.47, which is now severely unaffordable, and Vancouver is off the fricking chart at 7.8 for the average of all residential properties and 10.6 for single-family homes.

Canada as a whole? The average income for “economic families of 2 persons or more”, according to StatsCan, is $70,300. The average house price, according to CREA, is $324,779. The multiple: 4.62, or seriously unaffordable.
And, troops, I will remind you this is with the lowest mortgage rates in the history of ever, and with national unemployment increasing in a trend not expected to crest until next year.

Conclusion: Without a giant leap in family income, this is an unsustainable situation. With an increase in mortgage rates, it is unsustainable. Without a full-blown recovery and inflationary increases in wages and salaries, it is unsustainable. With any increase in income or sales taxes, it is unsustainable.

Any further price increases, then, will simply hasten the inevitable.

All booms end badly.