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More stress

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First, the MSU: “Long time reader of your blog; no doubt one of the best places to get sound financial advice.” Now, here is Ray’s question, on a day we have big financial news…

“I have a fixed rate mortgage ($700k @ 2.74%) which will come up for renewal in September 2024. The wife and I have a combined household income of about $280k. The question is should I just keep making regular accelerated payments on the mortgage without paying it down more or should I be paying down as much as possible before renewal. I anticipate that at renewal my rate will be way higher; and I worry that post renewal I will have high mortgage payments. Of course if I am not paying it down then I would use the funds towards my RRSP and TFSA.”

Well, seven large at Ray’s cheap rate costs just over three grand a month. The same amount financed at the current three-year rate (5.59%) requires $4,300 monthly. And we’re not done yet. Bond yields have been rising again while stocks dip and CBs make it clear they have not finished tightening. Oh, and real estate values keep falling, More of that to come, as well.

So, is it wise for our blog dog to throw more money into his home equity when the property value is likely declining and he has a mortgage that’s 4% below the inflation rate, because he’s afraid of what might happen in two years?

Our answer below.

Meanwhile did you hear about the stress test? Despite furious realtor lobbying to have the hurdle scrapped, it stays. This means anyone looking for a home loan must qualify at an effective rate of around 7.4%, unless they’re borrowing from a hopped-up credit union or Harold The Jewelry Buyer Mortgages.

With sales crashing and prices melting, why would the federal bank regulator maintain this test?

Here’s why: “In an environment characterized by rising mortgage interest rates, sustained high inflation and potential risks to borrower income, it is prudent that lenders continue to test borrowers for adverse conditions.” And this: “In times of economic uncertainty with increasing vulnerabilities, the MQR [minimum qualifying rate] has and continues to be a key tool supporting sound mortgage underwriting.”

Because, in other words, OSFI figures things might get worse. It’s also why the banks’ capital requirements were just tweaked. The health, stability and security of the banks trumps homeowner anguish – because the Big Six are ‘systemically important’. If a collapsing property market whacks, say, CIBC, we’re all pooched.

The regulator has also announced that next month it’ll launch a review of the stress test which will also “progressively include other mortgage underwriting standards.” This is code for more restrictions, tighter guidelines and reduced borrowing capacity. It’s bad news for the humpers at LePage and Re/Max, desperately trying to convince you that ponies and puppies will return in the spring.

Also today, the latest national stats. Ugly.

Sales fell across Canada last month at an annualized rate of just under 40%. That’s consistent with the year/year drop in YVR (more than 52%) in the GTA (49%) and tertiary, once-torrid markets like K-W (down 43.7%). This dashed the false claim the market had stabilized this fall, with positive stats in October. The wizards at CREA admit 60% of all markets in Canada saw lower sales in November, led by Vancouver, the GTA, Montreal, Edmonton and the Fraser Valley.

The average house price no longer tops seven hundred thousand. At $632,802, this is a 12% drop. Of course, in Chilliwack, it’s a 25% haircut. In King, 40%. In Toronto the average detached is 23% cheaper. In Kitchener, a 13% drop, to $808,609.

Say the realtors: “”Weaker sales activity should push prices even lower in the near-term. However, our forecast calls for average prices to only partially retrace their pre-pandemic gain when they eventually bottom. An unanticipated surge in resale supply would undermine this view, but so far the rate at which new listings are hitting the market has been subdued.”

It’s true. Mucho sellers withdrew from the market since July because prices were dropping, multiple bids were gone and buyers staying home. The trope now is that rates will drop in 2023 and the frenzy will resume. But when it becomes evident rate hikes are continuing through the first half of the year and CBs have zero intention of backtracking – now with the threat of more mortgage restrictions coming – people who must sell will probably list. And down she goes.

As mentioned here lately (often) higher mortgages have not yet been offset by price plops. In order for this market to avoid a freeze-up, real estate valuations must fade. A lot. Now that there’s no stress test relief, no return to 40-year mortgages, no rate cuts coming and no surge of new supply homes available, how can that be avoided? Huh?

Back to Ray. Keep throwing money at his cheap mortgage when the value of his house may be falling?

Well, renewal in the fall of 2024 is distant. If the CBs win the inflation fight and we sail through a brief recession, things might look a lot less scary. Meanwhile we know rate hikes will pause next year, that the Ukraine war is likely to wind down and inflationary pressures will abate. Equity markets love that stuff. Stocks should rise. Bonds, too. Why not divert household income into TFSAs and a non-registered account to enjoy some growth, diversify, and have a bigger pool of money to deal with any surprise when the mortgage comes due?

The risk of investing: financial assets might perform poorly. The risk of paying down the cheap mortgage faster: burning up income and net worth in a declining asset.

A classic Mars or Venus dilemma. I know my choice.

About the picture: “Hey Garth,” writes Raigan, “I was really hoping this email would wait until 2023, but when it rains it pours: we just had to say goodbye to our other corporate fat-cat, Dr. Doom. She lasted for 19 wonderful years, longer than any of the vets predicted, powered mostly by treats and belly pets. Thanks again for all of your hard work spreading sanity and animal appreciation in equal doses.”


Source: https://www.greaterfool.ca/2022/12/15/more-stress-3/


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