The other day I read an article that suggests that many Canadians would have a problem if the market value of houses were to drop. We have been warned of this crisis to come, but we choose to ignore the reality of the situation.
It is true that a recent study suggests that the housing market is overpriced by as much as 30 % of its actual value. The study is based on solid financial data regarding the valuation of houses. But as we all know your house is always going to be worth what someone is willing to pay for the house. As long as the banks make mortgage rates attractive with low lending rates the housing market will continue to flourish. New starts will continue to happen and the market will be flooded with homes and potential buyers.
The issue is not with the banks or people who want to own a home. Buying a home and creating equity within that purchase is solid financial planning. The issue for me is that governing guidelines for home ownership are on the weak end of regulation with little or no protection for the buyer. When my parents were looking for their dream home in 1970, you had to put a 25% downpayment on the house of your dreams. That seemed like a lot and at that time and it was. The median price of a house in 1970 was $23,00, the minimum wage was $1.60 per hour. As it turns out that 1970’s home, which only had 1,000 square feet of living space, would be considered a garage in today’s homes. But 45 years ago it was home, the place you grew as a family. Today that home could be worth anywhere from $440,00 -$750,000 (or more although I shudder to think that it could be) depending on where you live in Canada. Jump forward 45 years and in today’s market you only need 5% as a down payment to purchase a house, and the average minimum wage in Canada is $11.40.
As the article I read would suggest if you only put a 5% down payment on your dream home today. You could have a negative equity valuation if the market valuation drops as previous data suggests is possible. The CMHC requires mortgage default insurance be added to the mortgage principle if your down payment is less than 25%. You, therefore, will be increasing the debt on your home, in simple math there is no longer 5% equity in your home you would now be left with 1.6% equity in your home on the first day of ownership. This is why the economists believe that some new homeowners would be in trouble if there were a decline in house market valuations. We have seen this before, 2008 the housing collapse in the United States or 1980’s when the highest interest rates in Canada caused many to walk away from their homes as they could no longer afford to pay the mortgage on their home or buy a home with mortgage rates of 15% -21%.
Does owning a home mean equity? Yes! It should create a positive equity position in your life.
To illustrate this use the numbers from before: hypothetical situation just using numbers that are presented here in the article for ease of understanding.
The original house was bought for $23,000 (1970) and sold for $440,000 (2015). Yes, there is value in home ownership. But the equity gain that happened in this illustration was over a 45 year period with completely different family values, employment, and wage opportunities.
So why do we believe that a house we buy today would be worth 10% -20% more in its value on a yearly basis?
Again simple math would mean at 10% our $440,000, 1,000 square foot home would double in value after 8 years.
Has our reality changed that much?
Will our earning potential be that much more in eight years?
Does this suggest that because you think your dream home is nice that someone else should pay you 25% – 50% more for the privilege of owning your home?
Well, the funny thing is that it happens more often than not in today’s society. People who buy houses today have been able to make money on the resale of their investment. It has become the norm in society that your house will pay you a big return when you sell. Although some people have their biggest asset tied to a market that could correct itself at any time in the future. Based on today’s regulations, if you met the minimum requirements and house valuations were to drop by 10%, you would have no equity invested in your home. Your ability to sell and get your money back would be limited to how much someone else is willing to pay for your home.
So, believe it or not, we are on the brink of a major problem should interest rates rise and the housing market correct itself. The ability to live on credit is real, but you still must plan for the future and make sure that you can afford your present lifestyle should a change occur.
Be smart about home ownership invest in what you can afford go back in time and know that a home is a place to grow our foundation. It does not have to be a castle, but it can be your castle.