Peter wrote me earlier this week. Nice kid. With a confused mom. “I discovered your blog about a year ago and have become a saver and investor since,” he says, in the mandatory suck-up portion of this letter.
“My mother is currently living in the house we grew up in, however we’ve moved out and she’s by herself now in 4 bedroom plus den house. She’s 53 years old and there’s only about 200k on the mortgage of this detached 905 home. I’m urging her to sell, invest and enjoy her life debt free and liquid. However she wants to buy a million dollar property close to the city. It’s hard to argue since buying a house has worked out well for people in recent years. I wanted get your advice on what her best course of action would be at her age and financial situation. Thank you for all your work, and for being the voice of reason in these weird times.”
I replied: What is your mother’s income? What is her employment? What are her assets? Is she on her own? Does she have a pension coming?
Says Peter: “Her income is around 50k. She does interior design, custom drapery and alterations around, but income varies year to year. She also gets about 1k a month from my grandmother’s retirement pension (they live together). And also another $800 a month from renting out the basement.
“Besides the house, worth maybe $900,000, she has $50k savings. No pension.”
Shudder. Is this the face of Canada? I fear so. Pete’s mom has net worth of $750,000, with 93% of it concentrated in one asset. If she buys the fat house, she’ll have 100% in one asset, at one address, in one suburban hood – plus her debt will increase from by 50%. At 53 years old, in a menial job, she’ll have no liquid assets, no pension income (beyond CPP and granny’s grand a month) and be forced to rent out a portion of the residence. Her mortgage will certainly renew higher every five years, and she’ll probably never pay it off.
Financially unstable, vulnerable, at risk – and living in million dollar digs. If a housing correction ensues, or mom loses her job making curtains, or the economy reverses, or interest rates inflate, there’ll be a crisis. Without liquid assets to tide her over, she’d have to sell – likely happening when buyers are scarce, prices falling and houses turning cold and illiquid.
Peter’s mom (with $700,000 in equity walking into a $1 million deal) does not require mortgage insurance. She will qualify for bank financing at barely over 2%. She won’t have to go through the mortgage stress test. There’ll be nothing standing between her and own suicide-by-horniness except her brave blog-addled son. And meanwhile (surely) her friends will tell her how astute she is to be ‘investing’ in a better house and what a success she’s become.
But what if she took his advice and bailed? Well, that $700,000 put into a non-registered investment account averaging 6-7% would double before she reached the age of 65 – even faster if she stuffed TFSAs for herself and gran. From the $1.4 million she could draw a retirement income of about $84,000 (at 6%). If it was set up as a return-of-capital distribution, then it would be non-reportable income, meaning she could keep and spend it all, plus collect her $18,000-per-year in CPP and OAS without much, if any, clawback. So instead of owning a house on which she could barely afford to pay the mortgage, property tax, insurance and maintenance, she’d have an income twice that of when she was working.
Of course, mom & granny would have to rent. But the cost of doing so is equivalent to carrying an existing $200,000 mortgage, plus property taxes and related occupancy costs, less the rental income. In short, by cashing out at the market peak (or close to it) with rates at the bottom (or near) she’d capitalize on windfall gains, eliminate real estate risk, create her own pension and cement lifetime financial security. Or, she can fall for suburban house porn, roll the dice and face an absolutely unknown future.
Housing analyst Ross Kay predicts Canadian real estate will plop in value by 17% after Monday’s mortgage rule change. Royal LePage’s Phil Soper says this is housing’s “last hurrah.” CMHC is raising its risk assessment of the overall Canadian residential real estate market from ‘moderate’ (orange) to ‘strong’ (code red). Moody’s Analytics says Canadian interest rates will move higher over the next two years. Dominion Bond Rating Service says it now takes 82% of income in Vancouver and 50% in Toronto to afford the average house – all but assuring prices will fall.
Does she know any of this?
Finally, as this pathetic blog has said for some time, things will get a lot worse in the burbs than they become in the city. Leafy urban enclaves or detached houses a short haul from downtown are not going to lose 40% of their value. But you can’t say the same for McMansions in the hinterland. Worst. Choice. Possible.
So, Petey, this is on you. Save mom.