Entries from December 2010 ↓

Worry

Days ago I described a soulless outer appendage of godless Toronto where debt stalks the burbs. Thousands of families moved into rows of big houses with little equity and insatiable house lust. For many, it was a disaster – unable to afford the lifestyle that bankers facilitated. It many ways, a microcosm of what 2011 will bring across the country.

More on that in a moment. As they say on Channel 7 Action News in Los Angeles, we have an eyewitness account!

Speaking of California, just received this email from Jeff. At age 40, after 15 years of living in Socal, he’s moved back to Vancouver where, he says, everybody is swilling the Kool-Aid.

“I haven’t heard one thing from anyone’s mouth that I didn’t hear in southern California five years ago. It was unfathomable there that your house could be worth half what you thought it was currently worth. After all, everyone wants to live in the sun, right? Markets there are in the toilet and will continue to be as credit is extremely tight and stable employment is a risk factor for many. No bank wants to announce that they have increased their exposure to residential mortgages, so values continue to slide. What people in Vancouver don’t seem to understand is that having strong banks is irrelevant. I can draw a chart of housing prices that dropped my house “value” from $900K down to $400K.”

I’ve said this before, but here it is again: 2010 was the year when housing sales declined, year-over-year, for an unprecedented six consecutive months. 2011 will be the year prices follow. The correction that will stun the media (not that hard these days) will be but the initial stage. Following that, a multi-year melt.

As Jeff reminds, a real estate recoil after years of rampant gains can be one ugly mother. In case you missed the latest news, the most recent drop in US house prices was twice what had been expected. After losing a quarter of their value, homes fell in October at the rate of 15% a year – four years after the collapse began.

Obviously this has nothing to do with subprime mortgages (there aren’t any now), weak banks (Washington saw to that) or profligate Americans (consumer spending has withered). Instead, it’s all about public sentiment. People see real estate as a wealth sinkhole. So it is.

Expecting prices to go even lower, buyers don’t buy. And prices fall further – another 10% looks likely. Maybe more, since mortgage rates have started to rise (as they will here). In fact 2010 is the worst year for house sales in the USA in a decade.

The point is (as Jeff spells out) a house is a commodity whose value is determined by what someone’s willing to pay for it. What you think it’s worth is irrelevant. What you paid for it is your problem. What the neighbours got last year is ancient history. And once prices start to decline, while long-term mortgage rates rise, the economy sputters and taxes increase, buyers hole up.

It’s a human thing. When something’s hot and expensive, everybody wants it. When values fall, people back off. And when listings surge – as they will in about 60 days – supply overwhelms demand. Everything changes.

Now imagine what would happen to Carlyle, in desperate Milton, if the value of his home plunged, say, 20%. He’s already screwed, and I bet there are more screwees on his street. He writes:

So I’ve been reading this blog for a few months now … long enough to realize that I guess I’m a part of the problem. I don’t have any excuses … but I do want to make a change and that starts by tackling my debt head on.

My situation is this: 34 years old. Household income 110K before taxes. Mortgage 246k at 3.79 fixed (another 4 years) with house valued at 310 – 320K. Credit card debt 25.5K .  LOC is 11K at 6.75%. Car loan (at 0%), $13,125 owing.

So I called the bank to see about consolidation. They gave me 4 options:

1. Put all the credit card debt on the LOC — $900 mthly payment over 5 years
2. Get a Consolidation Loan for only the credit card debt at about $380/month over 5 years, and keep paying $400 a month on 11K LOC
3. Move the LOC balance and credit card debt into a consolidation loan at about $637/mth over 5 years
4. Refinance the house at same fixed rate of 3.79% rolling everything into the mortgage

I’m not really sure which is the best option to handle the debt. I’m fairly certain option 1 and option 2 are bad as I’d pay more interest over the long term especially if interest rates go up (and from what I’ve read here they WILL go up. The consolidation Loan, option #3 is kind of appealing as the interest rate would remain fixed, and the payments would be going to something non revolving which means more debt can’t be racked up (I plan on closing all of my credit cards except one with a very small limit)

The final option, refinancing is somewhat appealing from a cashflow perspective … our mortgage payment would go up only 120 dollars a month, although stretched out over 25 years. The downside of course being if interest rates go up we end up paying potentially thousands more interest. Opinions?

Carlyle is so toast. Even with his house at its imagined value, he has no net worth – and yet earns a salary 30% higher than the average. Obviously he’s living beyond his means, or maybe just being squeezed to death by the social Miltonian pressures to have a new deck, giant BBQ, kids with iPhones, SUV and four hi-defs.

Now imagine if his real estate devalues by a fifth (Milton is Canada’s Stockton, just as Van is our Socal). Suddenly Carlyle has a house worth the same as his mortgage. His equity’s gone, but the debt remains. Now imagine if he had opened Door Number 4, and rolled another $36,000 onto his principal, amortizing it over 25 years.

Not only would be under water by that amount, but he’d be unable to sell his house. After all, if he found a buyer at $248,000, he’d have to show up on closing day with a cheque for just under $50,000 (commission plus grossed-up mortgage and closing costs). Yikes. A prisoner in his own home. In Milton, yet.

Finally, imagine this was just the start, and this home continued to lose value for three or four years until, like Jeff’s place in the sun, it surrendered 55% of its value. The family would be financially destroyed. Not because they got a subprime mortgage, or lost a job, or speculated. But because they did what society wanted, and a banker made happen.

Danger surrounds us. It’s a good week to worry.

Choices

Toby and Calvin and asking for advice. They live in Calgary, so instead of running to MissyBunny or realtor Nikki, they’ve come here. We are so unworthy.

The problem seems to be whether to live in Cowtown or move to Skatch. As usual, though, nothing is simple – and of course merely by asking for advice, thus couple will now receive a wholly embarrassing financial assessment.

Here’s the story:

We are both 40, 2 children – 5 and 7 years old.  We live in Calgary but are from Saskatoon, been here since 1999.  We own a nice home in a good neighbourhood, the home today is worth approximately $600,000 (on a good day if a greater fool puts money down on it).  We have $225,000 in registered investments, $26,000 in TFSA, another $24,000 in non registered investments such a flow through (which give us great income tax advantages).  We have a mortgage of $217,000 (prime minus .60) and have borrowed $80,000 (at prime) against the house which has been invested in flow through and mutual funds.  The $80,000 loan interest is paid by dividends from the investments so technically no cost to us.  We have little consumer debt, maybe $3000 (I added in my head).

I stay at home with the boys and my husband works in sales salaried at $103,000 with a 20% bonus structure (which we don’t count on but are very happy to receive if it so happens to be).

I’m ready for the slaying after you hear my question so don’t hold back.  Out of the blue my husband has a very good chance of getting a job in Saskatoon that will pay about the same or more then he is making now.  We don’t know what to do.  We are torn between staying in Calgary and plugging along or moving to Skatch where our families are and we would be almost mortgage free.  As you know housing there is stupidly over priced, I would venture to say almost more then Calgary.  Fast paced Calgary, more to do, more opportunity for the kids and us.  Slow Saskatoon, great University, family and lakes.

So my question is do we stay or should we go?  Do we up-root ourselves and venture into the unknown (sort of) or stay here and keep plugging.  We don’t want to ask people we know because they are biased so you are the deciding factor (ok, that might be too much pressure to put you under) how about you will be the one to tip the scale for us……

Any advice from you will be greatly appreciated as I am trying to live what you write (maybe not as eloquently).

Well, Toby and Calvin, let’s parse the numbers. You have $275,000 in liquid assets and $297,000 in debt, and it doesn’t sound like there are any pensions coming due in your household. Of your total net worth of $498,000 (assuming the house is really worth six large), about 77% is in real estate – way too much.

What bothers me is the $80,000 LOC taken out for mutual funds and flow-through shares. First, the cost of the loan is 4%, and the MERs on the funds are likely in the 2-3% range, which means the funds have to be torquing out a return of 7% or so to even be in the game. Second, the reason there are tax advantages for owning flow-through shares is the same logic behind incentives for buying labour sponsored venture capital funds – most of them are mongrels. If they were decent investments instead of high-risk sinkholes, the government would not have to pay you to own them. (There are a few exceptions, of course, but not many.)

So whether you move or not, I’d recommend dumping these puppies and paying off the line. Now your liquid investment assets are $195,000 – and I hope the RRSP and TFSA form a balanced portfolio of bonds, preferreds, REITs and ETFs, among other things, with a nice 40-60, fixed-equity mix. (This is what my own looks like, and grew by 14% this year, with major tax avoidance.)

I mention this because if your portfolio is not swelling by at least 8% a year, hubs is gonna have to start knocking off liquor stores in his spare time. First, you have two short people in your house who will be going to university in about 10 years. That should be worth between $100,000 and $200,000 over six years – pretty much wiping out what you now have. Of course, when they’re finished sucking off your money and on their own, you’ll both be in your mid-fifties, and have only a decade or so to prepare for retirement.

How much will that require? About $800,000 would be a nice amount, able to throw off roughly $50,000 a year in income – assuming it isn’t all in an RRSP tax bomb – which should be enough to supplement CPP. Will this be sufficient to live on in 2035? Probably not, but it’s a start, which means you’ll likely have to eat through all of the capital and leave the kids some flash drives to remember you by.

So what does this have to do with Calgary or Saskatoon?

Well, the average Cowtown house is now $455,000 and the average home in Skatch is $313,000. Calgary prices have declined 10% from the peak, while Saskatoon prices are up 78% from 2006. There’s no doubt that Potash City is over-valued, and you should expect to lose equity the day you move in.

Having said that, if you can actually find an idiot to pay you $600,000 now and relocate without a mortgage, then presumably you’ll have more savings to throw at your investment portfolio. Your financial salvation might have a better chance of actually being achieved.

But then, it’s Saskatoon. You’ll likely die early of frostbite, ennui or locusts.

Hope this helps.