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Real Estate Bubble

February 26, 2020

There are real dangers in the real estate bubble, and they can be hard to spot amidst the excitement of buying a new home, whether for the first time or the umpteenth time.  The first, and most obvious, danger is that of a potential correction in prices.  In the last two years we have seen house prices double in some market sectors.  As house prices increase so do mortgages, as mortgages increase so does self liquidation of RSPs and other investments (to be used by first time buyers as down payments), then of course spending on credit cards and lines of credit continues to trend upwards too.

My office has seen an uptick of people who have “total equity mortgage plans” and some who have purchased homes without building inspection conditions or finance qualifying clauses.   Both of these factors put consumers at risk of losing their financial stability and their homes.  Buying a home, especially for the first time, is a very exciting event.  When I studied Real Estate, the class was told the average purchaser makes the purchase decision within seventeen minutes of seeing their new home.  That’s pretty fast!

Then they are hit with a whole bunch of unfamiliar moving parts, mostly related to the financial side of buying a house.  First, they are signing a legal contract of purchase and sale, usually without legal representation, for probably the largest financial decision they have ever made.  Then they need to obtain a mortgage, even if they “prequalified” they may still need to qualify again.  A one percent increase in mortgage rates means higher long-term costs. 

The purchasers must have a solicitor for so called “independent legal advice”.  It doesn’t take before they realize that the costs of vacating their former premises, paying CMHC insurance, legal fees and land transfer taxes is considerably more than expected.  The down payment they got from collapsing their RSPs, for the home buyers plan has disappeared and the mortgage is much bigger than they originally anticipated.  Of course, they may run up against some immediate repair costs, especially those that forewent the building inspection.  For some folks the repair costs may be recovered through an expensive litigation process and for others, well they didn’t know what to pay attention to in their haste.

Most people, upon buying a new home, replace furniture items and appliances but because they basically shot their bolt on the purchase they just go ahead and charge the stuff on a “don’t pay a cent event” or some similar financing arrangement.  It might seem like a good idea at the time but as they finally catch up to the time they have to either cash out or pay accrued interest, the decision is often to pay out using a credit card or line of credit with a lower interest rate – simply moving the bill from one envelope to another.  

Now about those “total equity plans” – many lenders have them and the quietly have borrowers unwittingly sign a mortgage contract with nary much mention of the implications.  It might go something like this “we have set you up on the total equity plan so that you don’t have to requalify for future lending and you’ll get preferred interest rates – just sign here”  some bankers may go into a little more detail but there is still no time for sober second thought, the mortgage officer (broker) set up a ten minute appointment, out of their busy day, to have you come in and sign the documents.  Certainly, insufficient time to read, much less comprehend fully, the consequences of the contract you have entered into that will bind you for many years to come.

By the time the client is presenting at the Licensed Insolvency Trustee’s office, looking for help with credit card and other debt problems they have no choice but to liquidate the property.  They can no longer cashflow payments and have no equity left in the property to consolidate the, higher-rate, line of credit and credit cards into a conventional mortgage.  Since all the debt is secured there is no option for filing a proposal, the bank would typically “carry the day” in a Division One and since the debt is secured against the real property filing a Consumer Proposal would probably not be helpful.  Should there be a correction around the time that the mortgage comes up for renewal, even if things have been going along without default, the lender can call for full payment on credit lines that exceed the adjusted value of the property.

Licensed Insolvency Trustees seem like a negative bunch of Nellies at times, we certainly tend not to be optimistic about the prospects of taking on excessive debt, and we have been singing the same song for years.  But, when a correction does come it comes without much warning, at least to the less than financially astute borrower.  One only need look back to the 2007/8 banking crisis and many of the same warning signs are in place again today.  Even economists have been unsuccessful in forecasting recessions, depressions and other economic corrections.  Be prepared, borrow less, live modestly and don’t spend what you don’t have.