Writing it off

‘Rates can never go up. The economy will crash.’

How many times have you read that doomy bleating in the steerage section comments? It’s a constant refrain from the over-extended, the uber-leveraged and the hopelessly indebted. They truly believe ‘the government’ sets interest rates and the Bank of Canada will act independently from CBs around the globe – just to ensure real estate values continue to inflate. Forever.

Well, surprise. Bond yields have escalated in Canada and the US. Inflation is running hot. Employers can’t find enough workies. Covid’s still here. The supply chain is busted. The price of everything is going up. Governments are spending to excess. And, yup, all this stimulus means central banks will be tapping the brakes, with the debt market doing it in advance.

Look, it’s already started. Right on cue.

TD’s the first of the Big 6 to jack fixed-term rates. The three-year is up ten basis points and the fiver advances by thirty. Now that doesn’t sound like a whole lot. And the deplorables will yell, “But I can still borrow oodles at barely over 2%”. They’re right. The new five-year fixed-rate cost is 2.29%. Still cheapo money when the official inflation rate is 4%.

But this is an increase of 15%. And it will not be the last. In fact, as stated, it’s the first. Variable-rate loans will stay put (or even fall a few basis points as the yield curve steepens) until the BoC starts adjusting its benchmark rate. Two increases are expected in 2022, adding about a half point to the prime and VRMs. Then, as growth accelerates in a post-Covid world, the cost of money could augment about every quarter.

Eventually current mortgage rates will double. If you took out debt in 2020 or beyond, better budget for a more costly renewal. And be aware that as mortgage rates rise, the amount of principal being repaid monthly falls. The best deal today is a variable rate, still available at about a full point below the prime rate. But, of course, that will be fleeting.

The impact on house prices?

Hard to say, given the current sicko state of the market. Sales have limped, prices have spurted, inventory has shrunk and we’re on the cusp of a big increase in the CMHC ceiling – allowing high-leveraged 20x loans on properties up to $1.25 million. More proof if the market can possibly be screwed up even more by bad policies, our current leaders will find them. Combined with the FHSA, well, anything can happen.

The evidence housing is out of control is everywhere. New data shows more and more households are borrowing against equity at low rates to invest in extra real estate. Multiple-property ownership rates are soaring as an increasing amount of net worth is funneled into one asset class. REITs and other evil corporate aggregators aren’t doing this. It’s your neighbours.

This is no surprise when a homeowner can borrow $120,000 in a HELOC at prime (2.45%) to buy and 100% finance a condo for $600,000, which rents out for $2,500. The interest-only payments are fully tax-deductible. Yeah, after carrying costs, opportunity cost, property taxes, insurance and condo fees the cash flow is negative, but so what? Specuvestors do it for capital growth. And the tax system encourages it.

Is this a good thing?

The dudes running NZ don’t think so. This week they did something about it.

On Tuesday New Zealand’s pneumatic PM, Jacinda Ardern, lowered the boom on residential real estate investors with a new law that – effective Friday – disallows the deductibility of mortgage interest. It’s a big move. Unlike in Canada where measure after measure is passed to augment demand (and prices), this kind of action throws icy water on the entire market. Interest deductibility for new purchasers will be banned immediately and phased out for existing landlords over the next three years. Critics complain it will hike rents, but the deed is done.

In NZ house values have inflated 26% in a year – a little less than in Canada, but enough to freak out the Kiwis. “Tax is neither the cause nor the solution to the housing problem, but it does have an influence, and this is part of the Government’s overall response,” said the finance minister. And he’s right. When investors – who receive a tax benefit – compete with residential buyers – who don’t – injustice grows. As stated above, when money is cheap, plentiful and tax-deductible causing prices to romp, why wouldn’t people jump in?

Well, during our recent “housing crisis” federal election campaign, nobody mentioned this. Instead we’re getting a new tax shelter especially built to inflate house prices, a higher leveraged debt ceiling and the government will be paying most closing costs with an enhanced credit. Plus you can write off the loan interest on a rental condo. But you can’t deduct interest on a TFSA loan.

Maybe when Jacinda’s done down there we could borrow her?

About the picture: “This is 10 year-old Rollie,” writes Kevin. “A throwback to the days where a nouveau boutique name was best left to hairdos than dog breeds. He is a border collie/Swiss mountain dog mix. As such, he LOVES catching and retrieving frisbees (border collie) and fervently “rescuing” half buried sticks found anywhere (Swiss mountain dog). Our most loyal friend sadly but humanely euthanized on this past autumn solstice. I’d love to see this beautiful picture of him as a tribute on your blog so all the dog-lovers here can see him as he was not long ago – still in his prime. And thank you for continuing your captivating, informative and timely blog posts despite what has to be tiresome exchanges with unthankful and unpleasant individuals.”