We are all fools; we prove it every day… We fall victim to the same cycles of economics consistently and more predictably than gas prices spiking right before the long weekend.
Markets and retailers take advantage of this phenomenon all the time, the best deals to be had on seasonal items is at the end of their seasonal cycle… when the days start getting shorter and nights get cooler we all of a sudden see those huge sale signs in the windows and too good to ignore offers to buy the latest styles and trends of the summer even though the season is at its end, how many times will you wear that bikini in September and October? The answer from many of you is it doesn’t matter; you bought it because it was a “good deal”
The same holds true for housing… and more so these days than ever before, several years now of ultra-low “too good to pass up” interest rates has fueled a fierce and uncontrollable fire that has consumed many un-educated and over indebted buyers. The cycle of Real Estate in Canada was clear in 2008 and 2009, it was destined to correct… the long term natural cycle of this sort of investment behaves like the seasons.
To avoid this correction the Bank of Canada pursed its policy of lower interest rates to near zero, the effect of this essentially being the same as the 60-80% off Sale signs that go up in store front windows at the end of a season… a last ditch effort to keep sales volume high, move inventory and protect the businesses bottom line from unsold stock. Real Estate in Canada exploded while all hell broke loose in the States, while their sales plummeted ours shot up and all the fundamentals of normal historical trends and averages went out the window. People BOUGHT houses, BOUGHT condos, BOUGHT anything REAL ESTATE… Mortgages were on sale, it was the BEST time to BUY and of course… Real Estate is always the BEST investment.
And if none of that convinced buyers, then the threat of interest rates eventually rising scared the crap out of potential buyers to stop “waiting and seeing” and jump into the market right away.
Where do we stand now? Well, interest rates are on the rise and it has nothing to do yet with the Bank of Canada moving on interest rates. The fact that interest rates have been rising considerably and consistently solely as a function of the Bond Markets should be concerning to all, this has the effect of increasing the impact that a near future rise in the Bank of Canada’s interest rate policy will have. When they start to raise interest rates, mortgage rates will follow and they will rise on already elevated mortgage rates that the bond markets have been responsible for.
So I guess that means everyone who has purchased in the past 3 years and heeded the advice of mortgage brokers and Realtors are going to come out ahead, they bought while mortgage rates were ultra-low. Allow us to address that another day when their mortgages come due for re-financing.
For those of you that are “waiting and seeing” let’s do some math and number crunching.
First, we need to buy into a couple basic assumptions here:
Number 1 – Real Estate prices are near their peak and will correct anywhere between 5%-30% depending on the region and product type
Number 2 – Interest Rates will rise
If you do not understand or agree with either of these two then you are just wasting your time reading on…
You are a potential buyer; you have an income that can service about $2500 per month of mortgage debt. Your options right now are as follows:
#1 BUY NOW because rates are on the rise, you pre-qualify for a 5 year fixed mortgage @ 3.5%. This gives you a maximum purchase price of $500000, you buy today and 3 years later your house value has depreciated 10% and is now worth $450000. You have paid out a total of $90000 over those 3 years with 2 years left until you need to re-finance at a rate guaranteed to be higher than 3.5%. You are technically underwater at this point.
#2 You decide to wait a bit because you see house prices starting to drop… at the same time mortgage rates are rising, you are worried your $2500 will not get you into a comparable house until you do the math. With a 10% drop in the $500000 house, it now is worth $450000 and with interest rates at 4.5% your $2500 will still buy you that house without you losing $50000. If we take it even further, interest rates at 5.5% and $500000 house dropping 18% to $410000 you now get the same house minus you LOSING $90000 in value.
If we take it EVEN FURTHER with interest rates @ 6.5% and house values dropping 26%, then that $500000 now costs $370000 and you have avoided LOSING $130000 in value, you are still paying the same monthly $2500 for the same house… Granted you are paying higher interest, however the important part here is your investment is in a better position now to APPRECIATE and GAIN value over time since you bought in LOW instead of buying in HIGH and LOSING VALUE right away.