By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929
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Did you know that only 4% of the population in Canada are debt-free? This means that only a very small percentage of people in this country are free from the constraints of not just record high unsecured consumer debt like credit cards and student loans but also mortgage loans.
Recently, I was presented with a graph demonstrating twenty countries and their respective debt levels. You may be surprised to learn that Canadians ranked the highest when it comes to those having household debt with a staggering liability of $1.75 for every $1.00 they earned. These numbers may signal an impending financial crisis is on the horizon.
This is simply a remarkably high percentage of debt that some argue is not sustainable in the event of a recession or job loss. I agree.
Based on the available historical data and state of the global economy, Canada will be heading into a recession soon. Some estimate it will come about in six months from now while others argue it will take one year. In any event, very few experts are opposed to the idea that a recession is coming which will directly affect the housing market.
In my opinion, consumers should always consider the predicament a recession may deliver and live accordingly. Financially planning with this mindset can act as a shelter against market calamities that, at the end of the day, are beyond anyone’s control.
Therefore, as a mortgage professional, I feel compelled to caution my clients about increasing debt levels and educate them about what a recession could mean when it comes to home prices and overall financial stability.
Canadians rely on their property’s equity when calculating total assets and this is well-recognized. In the past twenty years, it’s been an upward market with slowly decreasing interest rates and steadily increasing property prices and it’s because of this long standing price appreciation that many feel real estate is a type of investment incapable of risk. Clearly, this type of thinking can create problems since it only considers one side of the coin. Anyone investing knows that only considering the positive trend when making decisions can cause economic damages sometimes beyond repair.
The Government-implemented stress test provides evidence to suggest even minor preventative policy can have major effects on real estate. Case in point: When the stress test was enforced in 2017, properties all across Canada decreased by up to 30%. In fact, several borrowers who purchased real estate in 2015 through to 2017 currently owe more money on their mortgage than their property valuation. This means they have nothing but negative net worth. This also involuntarily binds them to their mortgage debt, creates the impossibility of refinancing to consolidate other higher interest debt that softens the blow and even makes it somewhat of an anomaly to sell since they would technically have to spend money to close the transaction due to the negative value of their property.
Keep in mind also that this national price depreciation did not happen because of an actual recession but as a result of a policy that was solely implemented to protect financial institutions from a recession and the rise of mortgage default rates.
Can you now start to imagine what the market would look like in actual recession?
This brings me to alarm bells about a recession and what it could mean for property prices. When interest rates rise, property prices will naturally decrease. As you can see, when interest rates are low, it stimulates the economy because it entices potential buyers to go out and purchase real estate since their mortgage payment is otherwise affordable on a monthly basis. So people rarely consider price (as long as they qualify) when buying a home and even fewer borrowers consider the reality of increasing interest rates and whether their house will still be affordable if interest rates go up 1-3%.
Big Debts and Renewal Time
If you have a mortgage and if interest rates rise, then at renewal time you will only be offered considerably higher rates. It’s important to be cognizant of this especially if you are currently borrowing other credit products like credit cards, student loans and unsecured lines of credit. A higher interest rate can add much bigger liabilities to your current obligations and for some, rising mortgage rates could become a financial tipping point in the wrong direction. As previously stated, in the event your property decreases in value, it may become challenging to sell or refinance since your property’s value will be much lower.
How to Plan
The good news is there are a few steps you can take now to protect yourself from the harsh environment a recession will create. Firstly, you should shorten your mortgages’ amortization period immediately. You can do this a few different ways. Firstly, you can set your payments to higher amounts which will force you to pay mortgage principal down rapidly. Secondly, your payments must be closer together to stop interest from accumulating quickly. Weekly and Bi-Weekly Accelerated payments are the best way approach mounting compounding mortgage interest.
Thirdly, you should also make a plan to utilize generous prepayment privileges that are stipulated in your mortgage contract. For example, some people pay over $15.00 a day on cafeteria lunch or frappuccinos. That’s over $400 a month they could be using towards their mortgage while adding years of financial freedom to their life span.
It may be time to quell consumerism and stop buying unnecessarily -focus on saving and growing your wealth through other investments.
I offer a complimentary debt and mortgage analysis. In a phone or in-person consultation, we will go over the following:
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