This week we look back into housing and answer the question: what house can I afford to buy? We also look into some awful footage from Ft McMurray, some more positive responses to the Black Lives Matter movement, and the bizarre bankruptcy of Hertz.
Weekly Pulse
Last week we wrote about how the GTA is similar to America in regards to inequality – primarily financially. When you see the footage of Chief Allan Adam other similarities start to come to mind. Despite the stats, the head of the Alberta RCMP denies systemic racism in his agency or anywhere in Canada. The RCMP commissioner has recently admitted the unconscious bias exists [watch video].
An Ottawa location of LIDS refused to make a hat with the text “black lives matter” on the front. The initial reason was that it was political, the follow up was it was under copyright. Let’s keep making this a priority to speak on.
In better news, Bell Media pulled Jessica Mulroney's reality series I Do, Redo off the air Thursday after the celebrity stylist was accused by Sasha Exeter of threatening the Toronto lifestyle influencer's career and trying to "silence a Black woman" during the anti-Black racism movement. The Bay, Cityline, and Good Morning America have also removed her.
The Toronto police are currently looking into re-budgeting in response to the defund police calls for action.
In financial news:
Hertz, a public company, declared bankruptcy and dropped to $0.56/share. In the ensuing weeks the stock went up 1200%. During this time executives sold $40,000,000 of stock (that we know about) and Hertz announced they would raise $1 billion to grow the business. Of course, this is a bankrupt company and the shares of the company have a strong possibility of becoming worthless as the debt holders take ownership. Robinhood at home trading has been the primary blame. Invest with caution (and if you own this get out).
The S&P dropped 6% in one day on Thursday as people became very worried about a resurgence of COVID cases. It is still up from when we first talked about it in May. As markets stay high government support will start to wane and jobs will likely stay lost as the new norm kicks into gear. This is still early. Invest in tranches.
Canadian cases are going down and we can now hug each other [read article].
Pretty much every economist is warning that the economy recovery will be very slow in Canada as tourism, hospitality and entertainment continue to be slammed.
The Jays made a huge splash as clear winners of the MLB draft by selecting Austin Martin 5th overall. If we ever get baseball back again the Jays will be a great team to cheer for.
What house can I afford to buy?
There is a lot of thought that goes into buying a house. It is very likely the largest single investment you will ever make. It will make up the majority of your current wealth and be the majority of your debt. With a purchase this large, comes fear - fear of missing a deal due to a crash such as a bubble or a recession, fear of buying before the crash and seeing your investment go down, and fear of over stretching and becoming ‘house poor’. Or simply fear of spending 10x more than you have ever spent on one thing before.
We have written extensively about how you cannot time the market. House buying is no different. What you can do is, know a good deal when you see one. We will talk next week about where we think real estate is going (up!) and where the best deal might be found. This week, we focus on how to determine what we can comfortably spend in an effort to narrow our search to areas we can afford.
Nothing matters more in purchasing real estate than knowing your relative comparable pricing. When CMHC tells us real estate will drop between 9-18% this year and only rebound in 2021 [read article] they are talking about all of Canada. This throws together Calgary (horribly affected by the oil crash), Vancouver (the most expensive place to live in North America by some metrics), Toronto (a city of 6.1M people), Winnipeg (the most affordable place to live), and St Johns (just a wonderful place). The belief that neighbourhoods in Toronto or Vancouver will change at the same rate is a bad idea – let alone thinking it will be the same for different cities.
This all starts with narrowing down neighbourhoods which means finding the max amount we can spend on a house. While we all may want to live in certain areas, it is often not possible due to budget constraints. In a 2017 survey, 62% of millennial home owners regretted owning a home as they felt they not only had no money to live on, but that they knew if interest rates increased, they would be – for lack of a better word – screwed (more on interest rate risk next week). We need to be realistic with our expectations when managing our financial health.
There are a few methods we can use to determine what house we can afford. The one most people use is whatever the bank tells you. We go in, we get pre-approved for a mortgage, and off we go. The bank usually has some ratios they use that are enforced by the government BUT it is of course in their best interest to give you as much money as possible. Many of us also look at down payments we can afford, or we use the internet to see if we can afford a rate. It is important to know how they all look together – affordability due to the down payment, and constant spending due to the debt.
For this, we look to a very strange but very effective rule of thumb: The 28/40 rule.
This rule states that a maximum of 28% of your salary (Gross monthly income – which is pre tax) should be spent on your mortgage, and a maximum of an additional 12% be spent on all your other debt payments (line of credit, credit cards, student loans) for a total of 40%. Can you do less? Of course. Is it better to have less debt – sometimes – but what we are saying is to be financially healthy, these numbers represent the maximum you can afford. To determine your maximum mortgage payment, divide your yearly before tax income by 12 and then multiply that number by 0.28, this will give you your individual (or combined) maximum mortgage payment. For example, if a potential buyer has an individual (or combined) income of $150,000 the equation to determine the maximum allowable mortgage would be as follows:
150,000 ÷ 12 x 0.28 = $3500/month maximum mortgage payment
Now for the down payment. This is the scary part. We all love to borrow and spend money we don’t have but when it comes to spending our own – especially this much money – we can all get pretty shy. As always, the more we know, the more confident we can be. Here are 4 need to know facts for down payments:
The minimum down payment you can make on a house in Canada is 5%.
For all down payments under 20%, you must pay mortgage insurance which will be an extra 3%-4% of the mortgage cost (assume 4%).
If the purchase price is between $500,000 - $999,999 a higher down payment is required. The minimum down payment is 5% of the first $500,000, and 10% of the remaining amount.
For any house above $1,000,000 you must make a down payment of at least 20% and you will not pay any insurance.
We now have our essentials and can figure out the house we can afford. There is a clear split at the $1M mark in terms of deposits required and rates – so we are going to look at sub $1M houses and over $1M houses in different charts. In order to keep some consistency, we are going to assume that we are all getting a 5-year fixed term mortgage which TD bank is currently offering at 2.82%.
While we are using a fixed mortgage in our example, variable rate mortgages have been proven to be a better idea over time when compared to fixed rate mortgages. Currently TD is offering a variable rate mortgage at 2.32% and some places are offering under 2%! Our parents would laugh at only paying 2% when they paid 18% for their mortgages in the 80s (and yet, somehow it was far more affordable to buy a house back then!). For our rates today, I would encourage you to shop around BUT when modelling your purchasing ability, always use the fixed rate to ensure you can afford the house if rates go up a bit.
Below is what we can deem a very generic house affordability chart. It takes into account the size of the down payment you need as well as the annual income you should have to ensure you are within a safe level of debt.
Sub $1M house prices :
Over $1M house prices :
One thing that sticks out is the difference that $1 makes between $999,999 and $1,000,000. That $1 means you need to fork over an extra $100,000 as a minimum deposit. But it also means you save $40k in the cost of insurance, and $400 a month in your mortgage payments (and therefore requires you to have less income to stay comfortable). The extra $100k down payment makes the demand for houses that are priced under $1M much higher than those priced over $1M. A less competitive market means better pricing meaning if you are close to that $1M range it may even be worth using a line of credit or borrowing via some other means to just push you into the next bracket (as long as you stay within the debt limits). Basically, you get better bang for your buck over $1 million if your budget is around this price.
Now that we see what we can afford, there is one key risks that everyone needs to be aware of. We call it interest rate risk. Next week we are going to do a much deeper dive on why if rates go up, we are all likely making more money and won’t care. For now, I want to highlight that there is always a risk that rates will go up. It is highly unlikely in the near term (2 years) – but it is likely after that. We are not going back to 18% rates but could we see 5% or 6% in the next 10 years? Sure. Again, we are going to push into why its okay if rates go up next week, but I do want to make that point clear.
In summary, use the fixed rate at the very least to calculate the house you can afford. Adjust your search in line with what you can afford. Be very aware of the current housing sales in your neighbourhoods of interest. Act fast and confidently. Get pre-approved today. Toronto 2-bedroom prices have dropped 10% since pre-COVID [see: Zolo]. Have they dropped in your neighbourhood of interest? Do the research and find out.
Next week we will look more into the current market and some short-term forecasts. We will look at what happened to the housing market in New York City, the financial capital of the world, during the last financial crash and what lessons we can learn from it. And we will provide our own outlook on the real estate market for the next 5-10 years.
Tell us what you’re interested in most. Are you wondering the risk of your industry or company? Want to know what the property market is doing? Thinking of investing? Leave us a comment or send us a note and we will answer that question for you.