Welcome to this month’s installment of Dear urbaneer, where we help answer questions that have been plaguing our clients.
This time around, one of our clients is weighing all of the financial implications of buying a house and extending his budget.
After several months of house hunting, with a few near misses and a few bidding war heartbreakers, I’m contemplating re-thinking my strategy. I’d set my budget prior to my house hunt based on my own comfort level and calculations, which was lower than what my lender had pre-approved me for.
I’m thinking about increasing my budget – and proceeding with CMHC Mortgage Loan Insurance with less than 20 percent down – with the assumption it will open the door to more choice, and potentially add more competitive power to my house hunt. I will admit though, I’m a little uneasy about the cost of it all, taking into consideration the high prices of homes and all the associated closing costs. On the one hand, it compels me to jump in while I still can. On the other I want to make sure I’m not getting myself in over my head financially. What should I do?
Willing, But Am I Able?
Here's our response:
You've done a great job of characterizing the Toronto property market, which seems to be on an upward climb that continues to push prices to new heights. If you didn't read last month's post, check out Dear Urbaneer: Why Is The Toronto Real Estate Market So Hot?.
Yes, there's definitely a sense of urgency to leap into that homeownership window while you can. One of the by-products of those escalating property prices is that affordability shrinks, incrementally but steadily. In fact, you might want to read Part One of our Spring 2015 Real Estate Forecast for some insight on the current state of affordability in Toronto.
That said, the urbaneer team are a cautious lot, so we recommend you not jump into the market without doing some due diligence. Good decisions are always informed decisions.
While there are certain advantages to increasing your budget, you do need to reconcile your personal relationship with money before you max out your debt load. First, how far are you pushing yourself out of your comfort zone? Are you risk adverse? Can you realistically be house poor, and rationally operate without having a sufficient financial cushion should an emergency present itself? Will the stress of debt be a detriment to your health and well-being? Could higher housing costs impact your relationships and quality of life? It's critical you be fully cognizant of how far you can psychologically stretch your budget in order to attain your ideal property.
Open The Doors To More Choice?
As you've discovered, the fierce competition is forcing most every Buyer to increase their budget in order to secure a property which best fits their wishes, wants and needs. Truthfully, given the scarcity of stock (especially in the freehold housing market) it's becoming more and more commonplace for homebuyers to scrape the high end of their budget (or come awfully close). Unfortunately, this is essential to win the bidding wars, especially when your objective is to secure a dwelling that will allow you to bypass one or more rungs on the property ladder. If increasing your budget will see you through a longer property ownership cycle – as opposed to multiple moves up the property ladder – in itself a costly endeavour – then we recommend you stretch your budget. Alternatively, we're increasingly seeing home buyers compromising on the condition of a property (Yes, we've all see those “fixer-uppers”) which remain in their price point, with an eye to renovating over time to suit their needs, as their increased income and budget allows.
Unless these borrowers are flush with cash, many are falling into the high-ratio borrowing category. It sounds as though you may be considering entering that category as well, by upping your budget and purchasing with less than 20 percent down.
Property Values Are Moving Targets
Remember that property values are variable, while the debt you take out is a constant figure. What if the market adjusts and your property value slips, where all of a sudden you owe more than you own?
While this may seem like an unlikely scenario – given the momentum of the Toronto market – we all remember it happening just six years ago during the U.S. subprime mortgage crisis, where greed for profit drove sketchy lenders to overleverage borrowers. There the market crashed. Values plummeted, and debt disaster struck thousands of homeowners.
Fortunately things are a little different here in Canada, where our stringent lending practices temper the likelihood of these scenarios. But keep in mind that if our market were to decline by just five to ten percent, a lot of high-ratio mortgage insured homeowners would find themselves in a negative-equity position. Given those premiums protect lenders (perhaps one reason why they're so comfortable approving your for sums that exceed your own comfort level) and values are spiking, safeguards are being put into place which include increasing the cost of the mortgage insurance premiums for all high ratio borrowers.
High Ratio = More Cost
Under pressure from various think tanks and governmental agencies, the Canadian Mortgage Housing Corporation (CMHC) has recently raised its premiums by 15 percent for what they deem to be high risk borrowers (again, those who have less than 20 percent down). These new premiums take effect on June 1, 2015.
This premium increase is a multipurpose action:
CMHC wants to send a message to high ratio borrowers to think twice about loading themselves up with debt. While some are well able to manage it, you invite the potential for disaster (or at the very least a few sleepless nights) if you overextend your housing debt.
This is actually part of a longer term strategy through which CMHC is topping up their coffers in the event that a mass softening of the market takes place, causing many to default on their mortgages – for which CMHC would have to theoretically bail out en masse. Ultimately, if CMHC can’t cover the costs, they would eventually trickle down to all of the taxpayers. It is proactive for them (and for you) to have cash flow on hand in the event of a major economic change.
This premium increase is also about optics. They want to remind homeowner that benevolent Big Brother is watching, and that they are monitoring the rising property values in the context of debt loads.
It may seem a little unfair to saddle homeowners with extra costs when buying a home when they are already paying so much already, but the collective impact of this move is helpful to the overall health of the economy.
It is widely believed that the overall material effect of these changes will be minimal (click here to read an article called “CMHC To Boost Premiums For High-Risk Home Buyers”), but they do make a bit of a statement. And it’s something to consider both when you are setting your budget, and when you are selecting your potential properties.
What’s Your Goal?
We ask all our Buyers how long they intend to stay in their purchase. Are you looking for a short-term ownership, or are you throwing your roots down for the long haul? Your time horizon should also dictate how closely you scrape the ceiling of your borrowing budget. Although you may have heard loads of water cooler chatter about people buying and selling homes in quick succession in Toronto and making a mint, when you add up all the costs it's not really the case.
Think about it. If that was true, wouldn’t we all be doing it?
When addressing the ultimate cost to the home ownership tally, be aware there are a myriad of expenses (over and beyond those CMHC premiums) which will whittle away at your bottom line, with a stronger impact if your time horizon is short. Click here to read our recent urbaneer post “How Much Profit Should I Expect When Climbing The Property Ladder?”. This piece brings into sharp contrast how the costs of home ownership in the short term can seriously dent your return on investment.
We encourage you to make sure your time horizon, purchase price and homeownership goals align with your budget. Without question real estate is a great investment – but it is a slow and steady one if you're going to realize the highest return. Most of us forget that our home investment is a heavily leveraged one, but if you're maxing out your mortgage debt just to get your hands on “the one”, you’re potentially leveraging it even more.
Remember, your budget is as much a part of your house hunting strategy as is your wish, wants and needs reconciling location and condition. And in many ways, it's potentially the most risky.
Part of successful and profitable maneuvering in the swiftly moving Toronto property market means having an ally by your side who has your best interest at heart – always. This may include enlisting the services of a realtor who plays “devil’s advocate” to ensure you’ve thought through every step of your home purchase. At urbaneer.com we don’t just want you to fall in love with your home on sight; we want to give you grounds for a long-term, blissful relationship with your home. Need help whittling out your house hunting strategy? Please know we are here to help!
~ Steven and the urbaneer team
Like what you've read? Consider signing up in the box below to receive our FREE monthly newsletter on housing, culture, and design, including our love for Toronto real estate and other unique urban homes.