By Hardcore Value
I haven’t been blogging much, nearly everything I do is on Twitter now. It’s pretty amazing how writing in 140 character intervals forces you to the core of your argument. Nevertheless I occasionally want to have a long rant so here we are.
How are Canadians budgeting these days? Like many countries there is a huge culture of home ownership in Canada. It makes for a great new facebook pic that unofficially says you’ve ‘made-it’.
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There are two issues that are very concerning for home buyers. First off, you have what I’m very confident is a real estate bubble in Canada. This has been discussed on this site since it was started and more recently in the media. That being said, the media focuses mainly on the condo bubble. Indeed I agree that condos are the most overvalued but much like the real estate bubble in the US which started with ‘just sub-prime borrowers’ a large correction in real estate prices will effect the entire sector.
The core of the bubble argument is the price to income ratio is at an extremely high level and will eventually revert to the mean:
And this run up in real estate prices was brought on by record low interest rates which has caused Canadians to binge on debt.
We’ve all heard this argument a million times and I’m not going to bring it any further today. Its my opinion, I’ve presented my facts and if you disagree with my conclusion that’s cool.
But back to the story, maybe you don’t care about what your house is worth in 2, 10 or 20 years, you are just buying it for pride of ownership. Again, that’s cool, not my cup of tea when it comes to your biggest investment, but my question is; how are people budgeting this?
There is a huge difference between the US and Canada in terms of mortgages. In the US, the standard government backed mortgage is a 30 year fixed. You can perfectly budget your mortgage expense over 3 decades. I won’t even mention other benefits such as writing off part of the payments. In Canada, our government backed mortgage is traditionally a 25 year mortgage, fixed for 5 years.
So Canadians really have no clue what their mortgage payment will be in 5 years. With record low interest rates, it’s not hard to imagine them reverting to a more normalized level. What happens if your mortgage payment doubles? (or worse), let alone if we have a recession and a big jump in unemployment. This is the problem with the ‘no bubble crowd’ which cite the current relatively low debt service ratios as evidence of appropriate real estate prices. Yes, service ratios are good now, with today’s economy and low interest rates. The problem is a mortgage lasts for 25 years and credit conditions shouldn’t be judged on today’s economic variables remaining constant for decades to come.
So How Are Canadians Budgeting For Higher Mortgage Costs?
Well I did some boots on the ground research. I’m 28 and more and more of my friends are making the big switch from renting to buying. I’ve asked them about this and I get very similar responses on Canadian real estate.
Real estate will always go up (recency bias).
Renting is wasting your money (they need to factor in potential capital losses and hidden costs of home ownership).
The bank approved me for this mortgage, therefore I can afford it (don’t let the bank’s poor decision making determine your own).
And in terms of what happens when they have to renew their mortgage in 5 years? Well I usually get a blank look and then something like “I never really thought about that”.
So there is your answer, Canadians don’t know and and don’t really care about future mortgage payments and housing prices. They are budgeting based on today’s current rates and happy to have their own place. They are busy with work and the every day problems that come with life. They are not economists and don’t spend their day thinking about income ratios and where interest rates will be in 5 years. I understand this way of thinking, but given the magnitude of the financial commitment, I’m nervous for them.
End of story, Canadians are extremely exposed to higher interest rates and its low on their list of worries.
Follow me on Twitter
The two people I follow most on twitter for Canadian real estate are Ben Rabidoux for great macro analysis and David Flemming, one of the most honest and insightful realtors I have ever come across.