Monday, January 24, 2011

Housing Bubble Inching Towards Its Peak

The low interest rate policy really worked well to keep the Canadian economy going on for so long. However, creating a mad frenzy where the buyers constantly kept heading out to purchase a house in hurry - was not really pretty.
Psychologically driven panic 'home buying spree' has always been magically convincing the first timers to participate in joy riding the bandwagon.
Yet, one of the most disturbing issues looming over the minds of many Canadians today is the overheated housing market, which has continued to drive higher due to easy credit facility, low interest rates and encouraging government tax breaks.

In some cases, there were multiple offers on resale properties, which were sold with ease way over the asking price. Surprisingly, every new location attracted extraordinarily long line ups, as if the houses would be given away almost free of cost. This of course was an invitation to the sellers to keep raising the prices and in some cases on daily basis. The buyers unaware of the gimmicks including catch 22 situation, usually ended up as the biggest losers. Actually, purchasing a house at lower price and paying higher interest rate is not different than buying a house at the higher price and paying lower interest rate. Manipulating the first timers worked really to the vendors’ advantage.

In fact, lowering rates was more beneficial for the speculators and the experienced buyers, who enjoyed flipping properties knowing the market psychology. Most of the credit goes to the new immigrants who kept such a market going on for so long. Under a scenario, when the rental payments are more than total monthly payments of mortgaged house, the tendency will be buying rather than renting.

Moreover, home buying spree due to temporary affordability creates a furious demand leading to the reduced inventory of available new and resale homes. And the Real Estate experts do their professional convincing in selling under the rules. Overpowered by emotional factor and the convincing factor, the new immigrants are easily pushed into a mental state where they are made to believe to “buy now or never.”

“Buy now before it's too late” actually creates panic among the potential buyers. However, there are negative signs due to fat inventory of homes and the reduced demand caused by many factors including recent government efforts to tighten lending rules, decreased number of employed youths, the retiring baby-boomers.and the reduced immigration. Difficult economic situation has been impacting the potential buyers with frozen incomes. Resultantly, the house prices are on their way down to hit Canadians really hard. Thus, the housing market has been cooling off since last summer reflecting 30% drop in larger cities.

In Canada it has been so easy to get mortgages with only 5% down and payments amortized over 35 years. More than 65% of Canadian mortgages are fixed for five years, but now the Canadians face more stringent renewal terms and most likely higher interest payments under newly announced rules. Government data shows that the average Canadians with a two-story home are spending almost 50% to 70% of their combined household income on mortgage servicing, thus, affordability level is still within a safe range in Canada.
The federal government plans to control borrowing and is currently focused on the condominium sector, with new rules in the works to make it harder to qualify for a loan on a high-rise apartment. Most probably, the government would add 100% of condominium fees to the list of expenses that is measured against income to decide whether a buyer can afford a mortgage. Whereas only 50% of the fee is currently considered. This means that there is a great potential of thousands of consumers to be out of the market soon.

Last April, new mortgage rules went into effect forcing consumers to qualify based on a higher interest rate. It also required all housing investors, as opposed to people who use a home as principle residence, to have a 20% down payment which mostly affected the condo industry.

Now, the prices are way higher than they were before the recession, and construction activity has been healthy. But home sales are now under pressure from the threat of higher interest rates, and Government’s latest move to curb 35-year amortizations is actually aimed at kicking a number of potential buyers out of the market.
Finance Minister Mr. Flaherty’s main worry is the Canadians are concentrating on too much long-term debt. Therefore, the government would no longer insure mortgages that are amortized longer than 30 years to pay off. Tightening the rules for existing homeowners who want to refinance their homes is also part of new policy. The maximum amount available for refinancing won’t exceed 85 per cent of the property’s value.

Since Canadian household debt has reached the enormous discomfort level and major portion of that debt belongs to real estate, so mortgage tightening is the answer, yet there is a risk of triggering a broader housing correction that is likely to hurt both consumer spending and the economy.

On the other hand, a number of Canadians are in a state of denial saying that the country's housing market is unlikely to have much of a correction of inflated prices.

Luckily, most mortgages were written under tighter regulations. And, sub-prime mortgages accounted for only 5% of the mortgages taken out in Canada, compared with 25% of those obtained in the United States. This indicates that Canada’s sound financial system provides some security for now.

Resale home prices are headed downward and are expected to drop by 7% on the average in the next 12 or so months. When almost a thousand boomers are turning 65 every day in Canada, what can you expect? Naturally, they are dumping their houses creating an oversupply into the market - not having enough buyers. Hence, the added inventory is likely to increase the downward pressure every day causing an economic chaos unless the government and the consumers remain vigilant enough to take all appropriate actions just in time. Otherwise, the declining home value would be gradually followed by painful level of diminished equity in the property hurting the home owners.

Without exaggeration, quite a large number of younger foreigners are needed desperately to replace the rapidly retiring Canadian population right away. An important key factor still remains an action by the federal government to enhance immigration quota from all around the world on equality basis in order to regenerate the lost economic activity leading to stable markets, sooner the better.

1 comment:

Anonymous said...

Homes are overvalued. Thus, it is already becoming a buyers' market in many areas. Price correction era is coming.


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