Personal Finance

Another real estate bubble?

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  • Dec 17th, 2013 5:22 pm
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Poll: Are we in a 2nd real estate bubble?

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Deal Fanatic
Aug 27, 2004
6822 posts
355 upvotes
Toronto, ON
GonePostal wrote: Day 1 you sign for a
95k mortgage (5k down payment)
5k cash back
Day 2
Foreclosure
100k property - 95k mortgage

It doesn't matter that the present value of a higher interest rate obligation. That's a moot point.
Hold on a sec. $95K mortgage, plus 5K cash back? That means the bank is out $100K on day 1.

On day 2, they... get $95K back from the sale of the property (assuming no transaction costs, etc).

Haven't $5K of the bank's money gone up in smoke on this?
Banned
Jun 19, 2006
9349 posts
54 upvotes
VivienM wrote: Correction: is viewed by PARLIAMENT as too much of a credit risk. The 20% equity requirement is in the Bank Act, AFAIK... or in the regulations.
The banks can buy sub-prime mortgages that aren't insured, they just have to do so through fancy structures, and they take a much greater charge against their regulatory capital (ie: Tier 1, innovative Tier1) to do so.
I have difficulty being as critical of high-ratio loans as you are. Used wisely (i.e. purchasing a modest property - which, in this era of inflated real estate, is ever harder to do), they let people buy a house much sooner than if they had to pay rent _and_ try and save up the extra 10-15% of the house price, which might take them years and years.
If they can't save the 10-15%, as renters, without all the expenses of a house, how on earth are they going to be able to save it as owners?? Does living in an owned house magically give a person a savings discipline that they didn't have before?
But take somebody like my parents. They bought a cheap new house (mortgage amount slightly higher than twice their income at the time) at 5%
I bolded the important part. :)
I don't think that there was anything particularly irresponsible about that...
High leverage can make people fabulously wealthy, yeah. But people are insane to be doing it on assets that have been in an almost uninterrupted secular uptrend for the past number of decades, especially when pricing is not 2X income, but rather, 6X income in most places.
"I worked with several H1B employees that were/are borderline ********. One of them wanted to spray an electrical patch panel with solvent to see if it would make the “network go faster”". <--- lol (source)
Banned
Jun 19, 2006
9349 posts
54 upvotes
VivienM wrote: Hold on a sec. $95K mortgage, plus 5K cash back? That means the bank is out $100K on day 1.

On day 2, they... get $95K back from the sale of the property (assuming no transaction costs, etc).

Haven't $5K of the bank's money gone up in smoke on this?
No, its a $100k property. The loan's face value is $95k. But the present-value of the loan is at least $100k, and probably higher, because the bank takes an additional fee.

The loan itself could not be liquidated for any less than $100k. So if they sell the property for $100k, they'd be even (minus all the service fees, of course).

Of course, CMHC premiums go ontop of this, which is why those cash-back schemes are up to 7% (with TD, I believe), *and* vendors give kickbacks as well.

The whole scheme fundamentally is based on fraud, but I guess, since our leaders in government have probably blessed it, nobody will be prosecuted or go to jail for playing along.
"I worked with several H1B employees that were/are borderline ********. One of them wanted to spray an electrical patch panel with solvent to see if it would make the “network go faster”". <--- lol (source)
Deal Fanatic
Aug 27, 2004
6822 posts
355 upvotes
Toronto, ON
pitz wrote: If they can't save the 10-15%, as renters, without all the expenses of a house, how on earth are they going to be able to save it as owners?? Does living in an owned house magically give a person a savings discipline that they didn't have before?
That depends on the price of the house compared to the price of renting, no?

In any event, 15% of, say, $200K is $30K. Saving $1K/month, that'll take you 30 months of savings (ignoring HBP/RRSP games, etc.).

If you're buying a MODEST property, ideally without condo fees and the like, your property can hopefully only cost you, say, $300-400/more than renting. Maybe less. In that scenario, if you had $1K left in disposable income, you're still doing all right.

Also, the thing is, you have to look at WHY people have low savings. Some people are irresponsible spenders. Others had job loss or tried to start their own business or something like that, but are not reckless spenders. Others recently went back to school.
pitz wrote: I bolded the important part. :)
Yup. And that's the problem today, IMO. Not that loans are high-ratio, but that they're low-interest and high-amount. At the time my parents got their mortgage, their 7.75%/5 years rate was considered a deal. Bank's posted rate was like 8.25%. But back then, you could buy a new 3 bedroom townhouse in a fairly central area in Ottawa for half the price of the same floorplan built by the same builder in a worse location today. I'm sure incomes haven't doubled since then...

Funny thing is, if you buy the same model house from the same builder today at today's price, the MORTGAGE PAYMENTS are not much higher. Borrowing twice the money at 4.25% instead of 7.75%, and maybe stretching your amortization to 30 or 35 years, will let you afford the same house with the same income. BUT... you'll end up in debt for far longer than with the old price and rates. (And your mortgage to income ratio is now 4X instead of 2X)
pitz wrote: High leverage can make people fabulously wealthy, yeah. But people are insane to be doing it on assets that have been in an almost uninterrupted secular uptrend for the past number of decades, especially when pricing is not 2X income, but rather, 6X income in most places.
This isn't about becoming fabulously wealthy... or at least, it shouldn't be. It should be about putting a reasonable roof over your family's head.

The problem is that, at some point in the last 7-9 years or so, people started to think that playing games with real estate was a great way to get rich. So instead of buying a house to live in for 20-30 years, they started buying properties with zero long-term usefulness, throwing money into improvements, and then hopefully flipping them for a big tax free profit.
Deal Expert
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Feb 9, 2003
18394 posts
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Langley
GonePostal wrote: That's a logical fallacy.

Just because subprime mortgages have some of borrowers with good score and CMHC insured mortgages have some of borrowers with good scores, doesn't make them the same.

A large contingent of borrowers who can qualify for a "subprime" mortgage can't qualify for a CMHC mortgage.
It would be a logical fallacy if I came to the conclusion that CMHC borrowers had a risk equal to subprime. I didn't.

I'm saying that subprime borrowers had better credit than most Canadians would assume, and CMHC borrowers are higher risk then most Canadians would assume.

GonePostal wrote: Banks bear the risk on conventional mortgages.
For CMHC mortgages, there are stringent guidelines put out by CMHC as to who qualifies.
No Canadian bank would risk committing fraud. It just doesn't make sense financially. The penalty for getting caught defrauding CMHC far out weighs the benefit.
I could be wrong about this, but I believe that the banks just purchase cheap insurance from the government for the other 80% and securitze the debt. The banks have no risk, and the CMHC doesn't seem to have credit score as a qualification.
What are the General Requirements to Qualify for Homeowner Mortgage Loan Insurance?
The home is located in Canada.
You will typically have a down payment of at least 5% of the purchase price of the dwelling, depending on the dwelling type.
Single-family and two-unit dwellings (5% minimum down payment)
Three- or four-unit dwellings (10% minimum down payment)
Normally, the minimum down payment comes from your own resources. However, a gift of a down payment from an immediate relative is acceptable for dwellings of 1 to 4 units. For eligible borrowers, additional sources of down payment, such as lender incentives and borrowed funds, are also permitted. Check with your lender for qualifying criteria and availability.
Your total monthly housing costs, including Principal, Interest, property Taxes, Heating (P.I.T.H.), the annual site lease in the case of leasehold tenure and 50% of applicable condominium fees, shouldn
Banned
Jun 19, 2006
9349 posts
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VivienM wrote: That depends on the price of the house compared to the price of renting, no?
Yeah, to some extent; for instance, the imputed rent from an owner-occupied principal residence is not taxable, whereas the actual rent from a rented house is taxable to the owner. This favours ownership over renting, if the imputed return on the house is *greater than* the financing cost.

If the financing cost is greater than the imputed return, then the advantage falls to an owner/renter, who is able to deduct mortgage interest.

In either scenario, with financing, the bank always takes its cut! :(

In any event, 15% of, say, $200K is $30K. Saving $1K/month, that'll take you 30 months of savings (ignoring HBP/RRSP games, etc.).
Yeah, exactly. Which makes these 0% down kids look kind of ridiculous, because there are lots of things that can happen to a house, especially a fairly new one (or an older one), that can easily swallow up $15-$20k.

Funny thing is, if you buy the same model house from the same builder today at today's price, the MORTGAGE PAYMENTS are not much higher. Borrowing twice the money at 4.25% instead of 7.75%, and maybe stretching your amortization to 30 or 35 years, will let you afford the same house with the same income. BUT... you'll end up in debt for far longer than with the old price and rates. (And your mortgage to income ratio is now 4X instead of 2X)
High interest rates have a fairly good possibility of going down in the future.

Low interest rates really can't go down any further, but can very easily go higher.

The 'big' problem with the real estate price rises is not so much that people have been locked out of the market -- but it is that capital has been diverted from useful businesses, that create jobs, and create exports, towards putting extra bedrooms on houses that really don't need them.
This isn't about becoming fabulously wealthy... or at least, it shouldn't be. It should be about putting a reasonable roof over your family's head.
The high leverage in a high interest rate environment made your folks fabulously wealthy though (compared to what they actually invested). Guess it just worked out that way :) .
"I worked with several H1B employees that were/are borderline ********. One of them wanted to spray an electrical patch panel with solvent to see if it would make the “network go faster”". <--- lol (source)
Deal Addict
Jan 11, 2004
1277 posts
161 upvotes
i6s1 wrote: It would be a logical fallacy if I came to the conclusion that CMHC borrowers had a risk equal to subprime. I didn't.

I'm saying that subprime borrowers had better credit than most Canadians would assume, and CMHC borrowers are higher risk then most Canadians would assume.




I could be wrong about this, but I believe that the banks just purchase cheap insurance from the government for the other 80% and securitze the debt. The banks have no risk, and the CMHC doesn't seem to have credit score as a qualification.



I don't really consider these qualifications to be stringent.

Further, risk of default during a housing crisis is most closely related to equity. 5% downpayment is 1% equity and that's subprime.

http://online.wsj.com/article/SB124657539489189043.html
Banks don't purchase the insurance the borrower does. That is why it goes on top of your mortgage.
You are mixing the US system with the Canadian system. As far as I understand 90%+ of the mortgages that Canadian banks write stay on their balance sheets. They don't securitize them and then sell them off.

Those are just general guidelines you posted. There are more detailed processes depending on the product you apply for. How stringent do you want general lending practices to be?

Again risk of default is more closely linked to equity in a home in the US. That is because by and large most of the loans given out were non-recourse. This is almost a foreign concept here in Canada (except those cowboys in Alberta.

If your house is upside down just leave the keys in the mail box and drive away in your Mercedes. An exaggeration of course but it paints the picture nicely.
Deal Addict
Jan 11, 2004
1277 posts
161 upvotes
VivienM wrote: Hold on a sec. $95K mortgage, plus 5K cash back? That means the bank is out $100K on day 1.

On day 2, they... get $95K back from the sale of the property (assuming no transaction costs, etc).

Haven't $5K of the bank's money gone up in smoke on this?
Don't get me wrong this is a terrible deal for the bank.

Once the bank gives you 5k cashback for signing the mortgage papers. That is effectively your money. Not the banks. Bad deal for the bank but if that's the deal you made, you have to live with it.
Banned
Jun 19, 2006
9349 posts
54 upvotes
GonePostal wrote: Banks don't purchase the insurance the borrower does. That is why it goes on top of your mortgage.
You are mixing the US system with the Canadian system. As far as I understand 90%+ of the mortgages that Canadian banks write stay on their balance sheets. They don't securitize them and then sell them off.
CMHC is involved in securitization of prime mortgages.

http://www.cmhc-schl.gc.ca/en/hoficlinc ... se_001.cfm

Basically, it works the same way as Fannie Mae/Freddie Mac in the USA.
Again risk of default is more closely linked to equity in a home in the US. That is because by and large most of the loans given out were non-recourse. This is almost a foreign concept here in Canada (except those cowboys in Alberta.
Most of the loans in the USA were actually recourse loans, since nearly everyone refinanced. Non-recourse only is applicable only in certain states, and only to 'purchase money' financing.
If your house is upside down just leave the keys in the mail box and drive away in your Mercedes. An exaggeration of course but it paints the picture nicely.
And where did the money to buy the Mercedes come from? From a mortgage refinance in most cases.
"I worked with several H1B employees that were/are borderline ********. One of them wanted to spray an electrical patch panel with solvent to see if it would make the “network go faster”". <--- lol (source)
Deal Expert
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Feb 9, 2003
18394 posts
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Langley
GonePostal wrote: Banks don't purchase the insurance the borrower does. That is why it goes on top of your mortgage.
You are mixing the US system with the Canadian system. As far as I understand 90%+ of the mortgages that Canadian banks write stay on their balance sheets. They don't securitize them and then sell them off.
2.4billion in Canada Mortgage Bonds at the last auction, with the banks paying 0.18% to the government to insure it.

http://www.canadianmortgagetrends.com/c ... ments.html

When a bank does this, it has no risk, and therefore, no incentive to screen buyers beyond the government mandated minimum.

Which, as near as I can figure, is a score of 600. Subprime.

http://www.canadianmortgagetrends.com/c ... nance.html

The banks might hold 90% of thier mortgage debt, but it looks like a lot of the new debt is going to securitized, so that number is going to fall.
GonePostal wrote: Those are just general guidelines you posted. There are more detailed processes depending on the product you apply for. How stringent do you want general lending practices to be?

Again risk of default is more closely linked to equity in a home in the US. That is because by and large most of the loans given out were non-recourse. This is almost a foreign concept here in Canada (except those cowboys in Alberta.

If your house is upside down just leave the keys in the mail box and drive away in your Mercedes. An exaggeration of course but it paints the picture nicely.
In the US, when you walk away from your house, you ruin your credit, but you don't have to declare bankruptcy. In Canada, you have to declare bankruptcy if you want to walk away from your house. Either way, you ruin your credit. Canada's system is better then the US, but $100k in negative equity will make a lot of Canadians declare bankruptcy. And this could happen. We already have had price drops of 10% in a year in some markets. 2 straight years like that, combined with someone who buys a $500k house with 5%... and the bankruptcies will be through the roof.
Banned
Jun 19, 2006
9349 posts
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GonePostal wrote: Don't get me wrong this is a terrible deal for the bank.
Why? The bank gets to originate a loan, have it insured by the government (so they never have to mark it down), *and* the ruse props up the value of their 'other' collateral in the rest of their mortgage portfolios.

Its an awesome deal for the banks, as it allows them to continue milking a very much over-milked market just a little bit longer. And the bank itself has no risk in doing the lending since its all insured.
Once the bank gives you 5k cashback for signing the mortgage papers. That is effectively your money. Not the banks. Bad deal for the bank but if that's the deal you made, you have to live with it.
So I lend you $10k in cash, and have you sign a promissory note to me for $6k, @ 50%/annum interest, for 2 years (no prepayment allowed!) -- you still think that $10k in cash 'belongs' to you?? Would you run around telling everyone you have 40% equity??
"I worked with several H1B employees that were/are borderline ********. One of them wanted to spray an electrical patch panel with solvent to see if it would make the “network go faster”". <--- lol (source)
Banned
Jun 19, 2006
9349 posts
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i6s1 wrote: In the US, when you walk away from your house, you ruin your credit, but you don't have to declare bankruptcy.
Only true for a purchase-money loan, in certain states. Not true for anyone who refinanced.

Plus when you default on a non-recourse debt in the USA, the lender issues an IRS Form 1099, which is essentially like a T4 or T5 slip in Canada, for the difference. So if you stiff the bank for $200k, you owe the IRS $50-$80k in taxes! Due within a year! (if a borrower can't come up with the money for payments, how the h*ll are they going to come up with it for the IRS?)
In Canada, you have to declare bankruptcy if you want to walk away from your house.
Same deal in the USA. The impact of non-recourse is extremely exxagerated. And it doesn't apply to 2nd mortgages (or related derivatives, ie: piggyback loans), nor does it apply to mortgage insurance (the insurer will sue you for any deficiency).
Either way, you ruin your credit. Canada's system is better then the US,
Better, for whom? At least in the USA, there was private sector capital involved in mortgage insurance. In Canada, the losses are going to be explicitly socialized. That means that people who saved their money diligently, put a 20% down payment, pay their taxes, etc., are going to be paying for the misdeeds of the 0% down crowd.
someone who buys a $500k house with 5%... and the bankruptcys will be through the roof.
Yup. Its actually worse in Canada because practically every mortgage has to be renewed every 5 years, and tested for solvency/eligibility. Whereas, in the USA, they do 30-year mortgages, so a borrower only goes into default if they miss a payment -- ie: insolvency can be hidden, as long as cash flow remains.

Its just bizarre to think that Canada won't follow the same path as the USA as far as prices are concerned, although the system of supporting banks through this mess is clearly more robust, and well-planned than that of the USA.
"I worked with several H1B employees that were/are borderline ********. One of them wanted to spray an electrical patch panel with solvent to see if it would make the “network go faster”". <--- lol (source)
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Jun 14, 2003
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pitz wrote: But does it make any sense? That's what you have to ask yourself. Can the average Vancouver family, for instance, ever earn enough $$$ to liquidate the debt against a house bought there, before the house itself is worn out? Its just basic physics -- they can't, which makes claims that the Vancouver market is stable and sustainable, ludicrous. Same with Toronto and its condo overbuilding and overpricing.
The same question has been asked for like 20 years already. It appears they can sustain. It is sustainable because the dynamic was changed.

1. People can afford $N per month. That $N could buy you a 2000 sq ft house 20 years ago. That $N per month can get you a 700 sq ft condo today.

2. The income of a family of 2 earners can afford $N per month 20 years ago. The income of a family of 4 earners can afford $M per month now.

The market is sustainable in a way that the unit is smaller and more people are needed to support it.

In Vancouver, no matter how bad the real estate market is. Its value is still somehow much more expensive than a unit of the same size in Toronto.
Too many people spend money they haven't earned to buy things they don't want, to impress people they don't like. -- Will Smith
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Deal Fanatic
Aug 27, 2004
6822 posts
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Toronto, ON
gman wrote: 1. People can afford $N per month. That $N could buy you a 2000 sq ft house 20 years ago. That $N per month can get you a 700 sq ft condo today.
And there's something wrong with that. But I guess the lefties have won: by successfully preventing the building of infrastructure to the suburbs, it is ever more difficult to get to your 2000 sq ft house, so people are just willing to be squished and live in undersized overpriced centrally-located.

*sigh* All this housing talk makes me want to move to Alberta...
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Feb 6, 2008
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i6s1 wrote: We didn't see a selling frenzy because people get a year of EI, then social assistance. People who were laid off could refinance at longer terms with lower rates.

The layoffs started last fall. Within a few months, we'll start to see people's EI run out. Once prices have started falling, more and more people won't be able to refinance because they have no equity, and they're already at the longest possible terms.

We saw roughly a 10% price drop between 2007-2008 in major cities in Canada, really with no trigger. Sales just started slowing, then prices started falling. It's not a selling frenzy, but people wanted to get out of a falling market.

Delinquency rates are low but climbing. The higher they get, the more upward pressure there is.

Interest rates are going up, because the government is spending more then it's making, so it either has to borrow more money (driving the price of a 5 year mortgage up) or printing money (which also drives 5 year mortgages up, because investors expect to be compensated for higher inflation.)


The biggest reason that I think that real estate will fall quickly is because it's a positive feedback loop. Rising prices encourage more people to leverage and buy. But falling prices cause more people to panic and sell. If we can get a 10% drop (in TO/Van/Cal etc) in a year with very little downward pressure, is it unreasonable to think that we could see 30%-50% over 5 years, with high unemployment and rising interest rates?
I plotted the historical mortgage arrears from the data here
http://www.cba.ca/contents/files/statis ... 050_en.pdf
[IMG]http://i30.tinypic.com/2ed8vg5.png[/IMG]

Back in the 89 crash, mortgage arrears didn't climbed past 1%. The 5% arrears in the US is a systematic failure. The US market crash is a result of subprime loans leveraged with CDOs. I don't believe Canadian lenders widely used financial instruments such as CDOs to hedge. So they didn't have the "insurance policy" which allowed them to do high risk lending. I could be wrong here, but I don't know where to find the information for this.





Where are you seeing the data that suggests a 30%-50% drop over 5 years? Your 30%-50% drop is purely based on unemployment and rising interest rates? I don't know what kind of unemployment rate you are expecting. But if unemployment keeps climbing, you won't see rising interest rates. Monetary policies are designed to combat inflation/deflation. They will only change it if they think the economy has recovered from deflation to inflation. The government would rather have a few years of slow growth, then a huge crash followed by quick recovery.

Here is the historical unemployment data from statscan:
[IMG]http://www4.hrsdc.gc.ca/auto/chart-diag ... _1_eng.png[/IMG][IMG]http://www.statcan.gc.ca/subjects-sujet ... 90807b.gif[/IMG]

Rising unemployment rate has slowed down a little now. I think people are just starting to realize that maybe the magnitude of this recession is not as high as they thought last year where people were panicing for a 2nd great depression. The aggressive monetary policies have helped a lot and they are still currently in place.

The current equity market is expecting a recovery some time in 2010. If unemployment keeps rising and the current economy doesn't recover, you won't get returns anywhere, not just real estate. Unless you put all your money in government bonds and hold until maturity, you will lose money in every investment if the market doesn't recover. Any bad news that comes out, equity market will be the first to react since that is the most volatile.

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