Sunday, March 11, 2007

How Much Mortgage Should You Have?



Some quick 2006 stats from the Canadian Institute of Mortgage Bankers and Lenders.
  • At present there are about 8.35 million owner-occupied dwellings in Canada.
  • Of these, according to the survey results, 65% have mortgages (the share of home owners who have mortgages is increasing – at the time of the 2001 Census the estimated share was about 55%). This indicates that there are about 5.4 million home owners with mortgages at present.
  • 21.5% of home owners with mortgages have renewed their mortgage during the past year.
  • Of these, 33% increased their mortgage principal.
  • The average increase in mortgage principal was about $26,100.
  • Combining these factors, the total amount of increase in mortgage principal due to equity take-out is calculated as $10.1 billion.

So the question is how much mortgage should an individual have or not have?

My general rules are:

  • Never borrow more than 3 times your annual reliable income (if you're have commission or bonus income, don't include 100% of the commission - be conservative - don't include 'expected' raises)
  • Never amortize your mortgage past your expected retirement date.
  • Attempt to amortize over as short a period as practical - 15 years or less is best
  • Try to structure your mortgage payments so you are paying more in principal than interest every month.
  • If you are young and planning on starting a family, do not borrow the maximum based on both people's incomes. Try to base your mortgage on one person's income.
  • Plan on a 2% increase or more in interest rates when renewing (rates go from 5% to 7%) to be conservative.
  • Ask yourself - Could I make this payment for at least 6 months if the worst happened? - job loss, illness, disability, etc.

I didn't mention some things that some people may feel are important, including down payments and percent income devoted to payments but I feel if the above rules are followed that becomes somewhat irrelevant. As an additional note on those two items though:

  • Use a down payment that reduces your transactions costs. I'm mostly referring to the CMHC mortgage insurance here. If you have non-registered investments that earn less than 1.5% more than your mortgage interest rate then you should use those investments as a downpayment or put them into a registered plan where taxation isn't an issue.
  • My personal feeling is that no more than 25% of gross income should go to TOTAL housing costs including mortgage payment, taxes, maintenance, fees, and utilities.

As always you should consult a professional financial advisor who can give you the ins and outs of any given plan.

32 comments:

machoslob said...

Good advice moh, for anyone facing renewal. For anyone not presently mortgaged, even better advice would be to stay unmortgaged until this market corrects itself. It has nowwhere to go but down....way down!

rentah said...

mohican: Many thanks for this excellent, sensible post. One wonders how few people are following these parameters when buying in the GVRD currently (5%?).

Anyway, your figures raised some questions for me on the last thread, and I'd like you to share your thoughts on this with us, so, for convenience, I'll repeat that post here:

----

Combining these factors, the total amount of increase in mortgage principal due to
equity take-out is calculated as $10.1 billion.


mohican, freako, guys_who_know:
I take it that's an annual rate, so that's the equivalent of 1% of GDP. Say all that was spent on goods and services in Canada (not necessarily the case, I know).
How much impact would it have?
How much of the GDP could be attributed to activity generated by such spending? How important is it? (and, conversely, how important will its disappearance be?)

--
It seems it'd be like BC losing more than $1Billion dollars of annual spending. How would that effect the economy? And how much of the argued rosy past economy can be attributed to this stimulus?

RentingSucks said...

What about if the 10.1 billion was put into further real estate investment. Even more interesting.

mohican said...

"It seems it'd be like BC losing more than $1 Billion dollars of annual spending. How would that effect the economy? And how much of the argued rosy past economy can be attributed to this stimulus?"

rentah - If the money spigot were turned off I wouldn't want to bet on a sales increase in the auto segment, in big ticket consumer electronics stores, or at home improvement retailers. I don't see too much other fallout from a reduction in that number. BC's GDP is around $145 billion so $1b in reduced expenditures is not catastrophic.

There are a lot of other risks to the BC economy right now. Most importantly, the forestry sector is being hit extremely hard by the slowdown in housing starts in the US.

manafromheaven said...

Someone attempted to share his/her concern about the forest industry yesterday on Chipmans blog, only to be shot down by the mental midgets who seem to dominate that site.

There was a list of mills that have already been shut down, many of which employ 300 to 500 workers. The disappearnce of jobs in primary industries which have spawned numerous spinoff jobs and parasites is sad ideed.

Warren said...

How much of that $10.1b was put into the stock market? The problem is we just don't know where that money is going.

However I think a lot of it goes into home renovation, that's what a lot of the HELOC ads seem to highlight. All other things being equal, that should increase the total value of the home, which is great.

Am I the only one surprised that more than 50% of owner-occupiers own their home free and clear? I know it has gone down, but that still sounds like a good number.

Maybe those are the people telling the rest of us to go out and buy a home, since obviously they are sitting pretty now.

RentingSucks said...

I have heard first hand of people using their equity in their principle home to fund the purchase of a second home. I wouldn't be suprised if this happened in the frothier condo market either. Probably not the whole 10 billion of course but I was trying to point out that there might be something of a virtuous cycle going on here that could turn vicious quickly if the money spigot stops.

rentah said...

warren said:Am I the only one surprised that more than 50% of owner-occupiers own their home free and clear? I know it has gone down, but that still sounds like a good number.

Actually, the figures imply that fewer than 35% do.

talus said...

I'm sure that I remember reading somewhere (VHB?) that Canadians have historically Mortgaged about 2.5 times their annual earnings while Americans were closer to the 3 times mark.

rentah said...

Here's an article from the WSJ today:

Why Your Home Isn't the Investment You Think It Is

Jesse said...

"Most importantly, the forestry sector is being hit extremely hard by the slowdown in housing starts in the US."

This is OT, but if companies are being hit, it sure isn't being widely reported in the news. Close to 30% of GDP is forestry-related. I hear stories of low lumber prices but I didn't hear a peep of the risk in the government's budget. Maybe the forestry industry has found a way to be immune to lumber prices!

This is on topic insofar as trees=money. Less of the money means HELOCs become a necessity instead of a luxury. Subtle difference.

"All other things being equal, [home rennovation] should increase the total value of the home, which is great."

This is a common argument. In a seller's market, buyers generally have no choice but to pay for the renos. In a buyer's market, well FWIW, homebuilders in the US have thrown in upgrades (read renos) effectively for free. Payback: zero.

People I know swear they can consistently make their money back and more rennovating. Makes sense: comparing 2 places, one with renos the other without, the renos obviously have a value. As long as the renos you do have a value to the buyer. But, as mentioned above, try competing with free upgrades offered at the newly built place around the corner.

Warren said...


People I know swear they can consistently make their money back and more rennovating. Makes sense: comparing 2 places, one with renos the other without, the renos obviously have a value. As long as the renos you do have a value to the buyer. But, as mentioned above, try competing with free upgrades offered at the newly built place around the corner.


That's why I said "all things being equal", which I should have equated to "long term average market appreciation". Obviously all bets are off in a falling market.

If you put $30k into a $500k home in the form of a finished basement or something, you're obviously increasing the value at least $30k.

Thanks rentah for the % correction, it was obviously too early in the morning for me.

Clarke said...

You really wonder at what some lending institutions are offering for sound borrowing advice.

This was probably about five or six years ago, but we were looking for a pre-approved mortgage for a condo purchase, and the "expert" said we were really under what we could realistically afford to carry in terms of a mortgage. If memory serves me correctly, the lender was arguing we should have gone for a house in our targeted eighbourhood. But when you actually crunched the numbers, it would have worked out to just under 38% of our gross income.

Oh, but I guess I forgot to factor in the fact that this was a great investment......

Nevertheless, I suspect a lot of people may be more than a little overextended, and it won't look much better if we see substantive drops in RE values.

Freako said...

"Say all that was spent on goods and services in Canada (not necessarily the case, I know).
How much impact would it have?"

I am no expert on macroeconomic calculations, but the formula is (care of wikipedia:

GDP = consumption + investment + (government spending) + (exports − imports)

The wealth effect obviously decreases the savings rate, and there increases the inverse, the propensity to consume.

Also, as per Keynisian economics, there is a multiplier effect which amplifies any changes,

mult = 1/(1 – mpc) = 1/mps

(mpc = marginal propensity to consumpe, mps = marginal propensity to save)

The other thing to keep in mind is that the GDP formula adds exports and subtracts imports. As well know, the meltdown down south WILL hit exports. AFAIK Vancouver/B.C. has a large trade surplus, and thus will be extra susceptible.

My guess is that a reversal of HELOC's would take a fair byte out of the local economy, all else the same. All else is of course not the same.

Freako said...

With regards to owning homes free and clear, I read several years ago that the average U.S. home equity had fallen dramatically, IN PERCENTAGE terms. From from 68 percent to 55 percent between 1967 and 2004. No doubt that has worsened further in the past 3 years, more so in the speculative markets.

This is very worrisome, especially since house prices are up, up and away. Hence one would expect average equity to be way up. If the average equity is 50% at present, a drop of 16.5% nationwide (not at all impossible) would wipe out a third off all home equity. Since home equity is by far the largest store of household wealth, the impact would be far reaching.

rentah said...

freako, thanks for the thoughts.

Freako said...

Another thing, the impact of the wealth effect isn't limited to HELOC's. People who feel wealthy consume more and save less. Of course, should housing prices retreat, the reverse will be true, and savings will overshoot. See Japan for a prime example of this.

aetakeo said...

Crazy. I found out that Stats Can puts the statistic "how many people own their houses outright" in their "tenure of housing" section, and also that I'd have to pay $130 to look at that info for 2001.
However,
New Zealand
used Stats Can info from '96, and at the time it was about 32% of people who lived in fully owned homes. 'Course, a bubble's happened in the meantime, and CHMC says there's a lot of HELOC withdrawal going on. (10 billion, I believe it said.)
But unless someone's got access to Stats Can, that would be all I know.

aetakeo said...

Oh, don't click that New Zealand link unless you want a 97 page pdf. I sometimes forget about modems, and I'm sorry.

Freako said...

"I sometimes forget about modems, and I'm sorry."

Modem? What is that?

Jim said...

Couple points on the GDP of the GVRD. The spending impact of the Olympics is about $5 billion with all the multipliers etc. over about 7 years(and its not all really incremental). The GDP of the GVRD is about $30 to $40 billion per year. The loss of the home equity withdrawal of, say, $1 billion at first seems insignificant until you add the multiplier effect and the fact that its all at the "margin" where its impact is further magnified.

rentah said...

good points jim: so the $1Billion+ pa 'equity extraction' (incorrect term intended for fun) has had more effect on the economy than the Olympic preparation spending. This isn't common knowledge, is it?

rentah said...

While we're discussion ownership rates etc:
Does anyone have/recall the following data from vhb discussions?:
1. Total number of housing units in GVRD
2. Annual turnover

Remind me of what the 'float' is here.
The WSJ article I linked earlier says that in the US the national average annual home turnover is 15%.

dingus said...

"With regards to owning homes free and clear, I read several years ago that the average U.S. home equity had fallen dramatically, IN PERCENTAGE terms...

This is very worrisome, especially since house prices are up, up and away. Hence one would expect average equity to be way up."

Add to that that in the US at least the ownership rate has exploded. Check the graph at

http://themessthatgreenspanmade.blogspot.com/2007/03/plankton-and-ponzi-finance.html

One component of the lower proportion of free and clear owners is the larger proportion of new owners, many of who presumably streeeeeetched to get into homes and are now on the knife's edge of wonky financing and falling prices.

A shift from 65 to 69% doesn't seem like much, however as that graphs shows, it's a colossal exponential deviation from the historical baseline, and rates above 65% have tended to be fairly quickly associated with falling prices.

Rob (sorry to keep coming back to Rob) believes (or says he believes) 'priced out' ftbs doesn't mean that much for the market. This analysis would suggest otherwise.

betamax said...

I read several years ago that the average U.S. home equity had fallen dramatically, IN PERCENTAGE terms....No doubt that has worsened further in the past 3 years

Good point re equity. Looking at the other side of the coin, I read in the Sun last week that ave. household debt (incl. housing) had increased by 50% since 1999.

50%! No need to wonder any more where the all the newly flaunted wealth (luxury everything) comes from.

Jesse said...

OT: census data. My favourite chart is this one. The maps are interesting too but are obvious just by driving around.

Here is the definition of "census metropolitan area".

licketyclit said...

Nice chart jesse.

So, WTF is going on in Barrie?
Either someone turned the Fort McMurray direction sign around or they've been handing out free viagra.

Jesse said...

"So, WTF is going on in Barrie"

Close to T.O. by the 400 and Go Trains. Could be anomalous depending upon how the city limits are defined: there are no other major cities adjacent so the city line could extend pretty far. I think also builders got to the city council. Same happened in Markham and Richmond Hill 15-20 years ago.

Jesse said...

On the census map for Vancouver CMA, interestingly, Coquitlam and North Burnaby have negative population growth. Speculation: mostly suburban-tract housing so kids leaving home leaves empty-nesters. This makes sense also as Coquitlam (anyways) has been hard-hit in school enrollments. Come on, boys and girls: we need more babies!

Other interesting bits: UBC and SFU show up big-time due to their new developments. Other areas of high % growth are almost entirely due to condo developments (False Creek, Collingwood, Port Moody, Edmonds, etc.)

The other site I love to look at is the City of Vancouver statistics. I can hardly wait to see this updated for 2006.

mohican said...

good find there jesse -

I'm amazed at the growth in some areas - Delta/Surrey especially.

Jesse said...

Not to harp on this, but this 1996 report answers affordability questions. The info is 10 years out of date but one can make logical inferences about homeowner income on a neighborhood level (not just median income, which is misleading in a city with high rental rates and a high income standard deviation). The 2006 report will be interesting.

captaincatbarf said...

Interesting population maps there jesse. I for one am not surprised in the least by some of the increases and decreases in areas. When I look at Richmond i think of all the changes i observed growing up there before leaving the parents basement.
A huge swell of people came in the late eighties and nineties due largely to the immigration influx. Now with the combination of slowing migration, land issues because of the ALR and affordability, a lot of the generation that i am a part simply can't or don't want to live there. Very few of the people i grew up with live in Richmond anymore. Either they are renting in other municipalities, buying in the Valley, or leaving Greater Vancouver all together like I have. The house of 4 i grew up in is now a house of 1 and rarely do I see kids on the block whenever I visit. Just my 2 cents.