Monday, June 4, 2012

Canada's housing market crash...the new reality

Its happened all around the world, and now its happening here in Canada, the inevitable collapse of our housing bubble.  There are still people in denial, especially those who've bought in during the frenzy of the past few years.  

Of course buyers have had good reason to dive into the market.  Banks were practically giving money away at what financial types refer to as 'emergency' interest rates.  Canada's banking system was supposedly more conservative in nature and subject to tighter regulation than our neighbours to the south.  And of course our media has been beating the 'buy now or buy never' drum.

After the euphoria, reality sets in.

Those super low interest rates mean higher mortgage payments at renewal.  During the first years of a mortgage, payments have next to nothing is going toward paying down the principal.  That means renewing for practically the whole amount at a much higher rate.

Our supposedly conservative banks started slutting out sub-prime 40 year zero down mortgages about 5 years ago, without even bothering to verify the value of the homes they were lending against.  The mortgage had government backing thanks to CMHC so the bank has zero risk.  Stated income was accepted without verification, and why not?  With taxpayers on the hook in the event of bankruptcy the banks posterior was covered.

And its only been in the last short while that media outlets have even begun talking about the possibility of a bubble market, while still trumpeting industry types who now talk of a 'balanced market' and the so called 'soft landing'.  Its the same language we hear just before a major recession hits.

I'm a big fan of Garth Turner's blog: Greater Fool, which is one of the only outlets which has been warning people of what will very soon be the new reality.  More popular are TV shows like 'Love it or List it' which get both homeowners and property virgins all hot and bothered to get active in the market, making industry players extremely wealthy.

Sadly I know of people who will get hurt.  One such example I'll call Bob, he will be closing on a Mississauga townhome in June.  The place cost close to 400 large and he'll be paying down a 30 year mortgage of about 350K.

Bob, like a lot of people, didn't see the point in throwing away money on rent.  On top of that everyone he knows owns a home, only losers rent....uhm, okay.

So instead of renting a townhome for 1,500 to 2,000...the same as what it'll cost him to occupy his GTA townhouse, he opted to part with $50,000 in cold hard cash for the privilege of 'owning' a home.  But if the same experts who predicted the US meltdown prove correct on their analysis of our market, then his home stands to lose about a third of its value.  

What does that mean to Bob?  It could very well fell financial disaster.  If his 400K home drops in value to 300K he'll have pissed away all of his down payment.  And when he goes to renew the mortgage he'll
need to re-qualify, which will mean coming up with at least $15,000 to meet the CMHC minimum equity requirement.

What if he can't come up with the do ré mi?  Simple, the house gets sold and he's left with a bill for the difference between the selling price and what's left on the mortgage.  In this scenario that would mean going from having $50,000 in card hold cash to owing that amount.  And why?  Because somehow owning a home has become the end all and bee all of a Canadian's existence, just like it was in the U.S. before their market tanked.

I think he would have been better off being a loser and paying off someone else's mortgage over the next five years while that 50K would have been growing into a even heftier down payment after the market corrects.

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