I try to ignore the doomsayers who glee in predicting the imminent demise of our real estate market. And so far, I have been right, as home prices continue to climb “The Wall of Worry”, in spite of increasingly tougher lending guidelines. But at some point, a sanity check will be in order. How will people in their twenties and thirties be able to afford to jump into home ownership if starter homes, townhouses, and semi detached houses keep rising higher and higher in price?
Thornhill Woods is one of many new suburban developments springing up north of the established Thornhill-Vaughan suburbs. It is defined as the area bordered by Highway 7, Bathurst St., Dufferin Rd. and Major Mackenzie Dr.
The south part of Thornhill Woods is filled with new homes, from townhouses to detached double-garage homes. The north part is still under development.
Last Fall, a long time client bought a near new semi detached home in the south part for $580,000. And this week, new clients made a successful offer for another semi for $580,000 farther north near Dufferin and Major Mackenzie.
Let’s break this down a bit.
Personal finance ‘experts’ recommend you save up at least 20% of the purchase price to avoid CMHC insurance. That would require $116,000 in savings, plus another $8,000 in closing costs.
Neither of these clients could do this. They first scrounged up 5% ($29,000) and the second managed to put together 15% ($87,000)
Luckily, interest rates are near all time record lows these days. The Fall clients scooped a five year rate of 2.99%.
They only have one car payment; a relatively modest $331 per month. The property taxes on their new home will be $400 per month. To meet the bank’s standard debt service ratios (32% GDS and 40% TDS), they needed a combined income of $112,000!
This resulted in a monthly mortgage payment of $2,676; more than $3,000 after tax dollars when you include property taxes!!
To me there’s something very wrong with this picture. Assume their new home is in perfect condition, and requires zero maintenance. They still have to shell out monthly for heat, hydro, water, rental water heater, cable, internet, etc. Say $500 conservatively.
This means our Fall clients will spend more than $3,500 each month (in after tax dollars!) for basic housing costs -a roof over their heads they can call “their own.” And they start out home ownership with a monstrous $566,000 first mortgage.
According to Stats Can, the median household income in Ontario in 2010 was $71,450. This family needed over $112,000 to barely qualify for a mortgage.
I punched their combined annual income of $112,000 into an online take home pay calculator, and it says their net take home pay is around $84,800 – just over $7,000 per month. So their basic housing costs will consume 50% of their take home pay. What if one of them becomes unemployed?
If they stay there for five years, their new mortgage balance will be $484,300 approximately.
What if home values declined 16%, as some are predicting? After five years, their home would be worth $487,200 -> effectively no equity in their home. And that is after pouring over $210,000 into it over the previous five years.
And say the renewal interest rate is 5%? Their monthly mortgage payment may increase by $506. And if the renewal rate is 6%, their mortgage payment could increase by $773. They would then be spending more than $4,000 per month on basic housing costs.
Now the reverse is true too of course. If values continue to rise, then leverage will work in their favor, and they could increase their net worth dramatically. A 16% increase in their home’s value would take it to $672,800 – almost $200,000 in equity.
And if interest rates stay low, and their incomes keep pace with inflation, then their monthly housing cost will shrink as a percentage of their take home pay.
But then again, for most of the past decade, variable rate mortgages were the better choice than fixed rate mortgages, and that isn’t the case these days.
Related Article: The risks of variable rate mortgages
And it almost never makes sense to pay a premium to take out a ten year mortgage (3.89%) versus a five year mortgage (3.04%) But more and more people are doing so these days.
Related Article: Ten year mortgages are cool these days
You pay your money, you take your chances. Good luck out there folks!
Related Article: The Biggest Housing Bubble in the World is in……Canada