Entries from August 2013 ↓

The shill

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I’ve done a little shopping this week, my contribution to deep research. The tour included seven houses, all listed in the normal zone for SFHs in decent areas of Toronto – between $1 million and $1.8 million. All have been on the market since at least June. One’s been seeking a buyer for six months. And one’s been for sale for a year.

Price? All have been reduced by at least $100,000, and three more substantially. If buyers don’t materialize by Thanksgiving, the sellers may seriously chop, or give up and try again in the spring.

This is not the market the realtors tell you exists – with sales and prices romping higher. Just a few days ago local cartel boss Dianne Usher said this: “The strong annual sales growth experienced in July was sustained in the first two weeks of August.  The fact that sales were up for all major home types in the City of Toronto and surrounding regions suggests that a wide range of buyers are active in the marketplace today – from first-time buyers through to existing home owners whose housing needs have changed.”

About the same time, the region’s builders announced that while new house prices have never been higher, in the past ten years sales have never been lower. New condo projects are down 70%.

Warns the head guy, Bryan Tuckey: “It’s important to understand that while we are experiencing record-high construction, these homes have been sold two to three years ago and are not an accurate representation of today’s new homes market. Sales activity in 2013 has been low and we will start to see the effect of that in two to three years.”

This is the reality of the marketplace. So are fat five-year mortgage rates. We’re now a society where a majority of people can’t save $10,000. The economy has largely stalled. And gas prices are set to explode, thanks to a new war.

But wait, there’s more. On Wednesday came a fresh study (BMO) reminding us how screwed the Boomers are (stop applauding). The bank figures if a couple wants an income of $54,000 (the average amount spent by current wrinklies) they should have about $1.3 million saved. But this is double what most people think they’ll need ($658,000). Worse, the average amount saved by folks nearing retirement is only $228,000 – which means they’re $400,000 short of half the amount they actually require.

Seven years ago 20% of near-retirees worried they were in trouble. Now 46% say they’re not ready for retirement. Ya think? And those seven years brought record-low borrowing costs and real estate inflation. Sha-na-na-na-na, live for today…

So how will they possibly survive? First, an amazing 71% say they’ll get a job after they retire, which makes you wonder what they think ‘retirement’ is. Second, fully a third say they’ll be punting the house to make ends meet. Of course they will. About three-quarters of Boomers have houses, while almost an equal number have no pensions. Now imagine the impact of three million more listings over the next few years on a housing market which will face higher borrowing costs and a residue of record debt. Who, exactly, will be Hoovering up those properties?

Connect the dots and you can see how seriously whacked most people’s finances are. GenXers and their kids have no money because they’ve all got mortgages. Boomers have saved a fraction of what they’ll need, because their net worth is locked in real estate. House sales can drop, but prices don’t – because the sellers need every cent. But eventually the dam breaks, and valuations drop. Anyone professing otherwise is shilling.

Like the North Shore Credit Union, for example, which has launched a new campaign aimed at getting those copter parents to hand over condo downpayments to their kids, co-sign the mortgages, and hope for the best. What a great idea! Suck off the inadequate savings of the old to create life-long indenture for the young. Faustus would be so proud.

This sign appeared in North Van days ago:

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This brings me to a bizarre report released hours ago by the Conference Board. You just know we’re in trouble when a right-leaning think tank writes a pro-condo report for a company that insures high-risk mortgages, and the media reports it as news. No condo crash coming, it says: “A flood of foreclosures and subsequent sharp supply increases is simply not in the cards.” But who said it was? We can have a perfectly devastating 15% correction, and never near crash levels. And probably will.

But the best part? Boomers will rescue condos. “While regional markets clearly vary in strength, all will benefit from an expanding population and a rising share of condominium-loving empty-nesters aged 55 or more.”

You mean those savings-deprived, pensionless, planless people who may never retire and need to turn houses into income because you can’t eat drywall?

Yup, that sounds plausible.

Sometimes I think the swill we’re fed couldn’t be worse. And then I remember Brad Lamb.

More on that tomorrow.

Be bold

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With mortgage rates spiked, how will people borrow?

Easy answer – most of them will lock up. Blame the recency effect. Humans tend to believe that whatever just happened (rising rates, dropping condos, Miley Cyrus) will go on forever. For the past couple of years, with the feds warning of higher interest, folks have rushed to cement their loans. Now a massive 85% of borrowers have mortgages of five years or longer.

Just what the banks want. That’s how they make bales of money – as was in evidence Tuesday morning.

In fact, coming off a week when everyone was yakking about higher rates to come, TD published a consumer advisory which asked the question, “Should I go variable or fixed?”. You will never guess what the answer was:

Based on the possible course of short-term interest rates as projected by TD Economics, we might be at a point of inflection where locking into a fixed 5-year rate could actually provide interest cost savings relative to a VIRM over the next 5 years. Locking in at today’s special 5-year rate at 3.8% would compare with an average VIRM base rate of 4.1% through 2017. Again, this is just an illustration of what the average interest rate on a five year mortgage rate could be given our interest rate outlook.

Really? This projection is based on a Bank of Canada increase of a full 1%, which will happen, but not starting (thanks to a crappy economy) until a year or so from now. When they come, the hikes will be in careful, bite-size, digestible chunks – which means the current 3% prime might not hit 4% until 2014. After that, all bets are off.

So, what’s the best way to borrow? A VRM can be yours at the moment for as low as 2.4% at some no-name mortgage company which also manufactures muffler hangers. At the major banks, it’s 3%. This compares with a five-year fixed rate of 3.79%.

Running those numbers, there’s absolutely no contest which is the better deal. Locking in a 3.79% will result in a monthly of $2,058 and interest costs over five years of $70,452. At the end of the term you’d have repaid $53,075 and still owe $346,724. With a variable mortgage at 3% the monthly would be almost two hundred less, at $1,896 and the total interest bill end up being $55,827. You’d repay $57,983 in principal, and end up owing $342,016.

In other words the variable rate (at 3%) costs less a month, reduces interest payable by almost $16,000 and repays the mortgage faster – by over $4,000. Not only that, but studies have consistently shown that a VRM, over multiple decades, is the cheapest way to finance.

The danger in this? Variable-rate loans are just that – variable. When banks raise their prime rates, up go VRM charges as well. And even though your monthly payment doesn’t fluctuate, the amount of interest being generated does. So as the cost of money increases, more of your payment goes to interest, and less to principal. For example, if rates popped 1%, then that VRM on a $400,000 loan would spawn about as much interest as the fixed-rate mortgage.

Is it worth the risk?

You bet, since most lenders will let you convert a variable into a fixed with a phone call. That means you can finance at 3% or less (if you need a muffler) for at least a year, then flip over to fixed if the economy improves enough to prompt central bank rate hikes. And remember – just because the Bank of Canada ups its benchmark rate does not mean long-term mortgages will move in lockstep. For that you have to look to the bond market – where prices are rising (as stock markets wobble) before the missiles start flying over Syria.

The bottom line is predictable. If you use your turn signal in parking garages and always put the seat down, then lock in. Otherwise, be variable. You only live once, baby.