Robert McLis­ter – Globe and Mail

There are thou­sands of 20– and 30-somethings out there who are tired of rent­ing. They’re itch­ing to buy a house but they have one big prob­lem: they don’t have enough of a down payment.

Unde­terred, some may fish a few toonies from between the couch cush­ions and scrape together the 5% min­i­mum down pay­ment required by law.

Many of these folks will then lock in a bargain-basement 10-year mort­gage at 3.89%, find a hip prop­erty for about $300,000 and move in. For these new happy home own­ers, life couldn’t be better.

But what if, seem­ingly overnight, the unex­pected hap­pened and home prices dove 15%?

Com­ment: Moot point, not going to hap­pen. It is folly to dis­cuss things like this that have 0% chance of hap­pen­ing. Prices are more likely to be UP 15% by the end of the year.

The mort­gage bal­ance of these young buy­ers would sud­denly be more than their house is worth. If forced to sell now, they wouldn’t be able to break their mort­gage unless they made up this short­fall from their own pocket.

Com­ment: Again, doesn’t mat­ter. My house has gone up $100,000 in the past 30 months – as has every­one else’s. Even a 15% drop tomor­row won’t erase that. But the real­ity is, with houses in such short sup­ply and inter­est rates remain­ing low for the fore­see­able future, prices will con­tinue to rise. Maybe at a slower rate, but even  cut in half, the rate of appre­ci­a­tion is 5% per year. Which is a LOT more likely.

Their only choice is to ride out the real estate cycle – and hope it’s not a long ride.

Com­ment: The old eco­nomic and real estate “cycles” we were taught back in grade 9 busi­ness class no longer exist.

If the above sce­nario sounds like a long shot, think again. Home prices are a two-way street. We”ve almost for­got­ten what sell­offs look like but, believe you me, they happen.

Com­ment: No, they are not. Since 1966, prices have risen every year except for 4 at the start of the 1990s. It is called infla­tion, all prices rise. Remem­ber Grampa telling you about movies for a nickel? Now it costs $15–20 to see a movie. Model T cars were a few hun­dred bucks when they came out 100 years ago. Now a fully-loaded Mus­tang is north of $60,000. Same with houses – from $21,360 in 1966 to $517,000 lately.

When prices fin­ish drop­ping, they some­times rebound – or they can stay flat… for years.

Com­ment: But they are NOT going to drop. We can play the same “what-if” game with an aster­oid strike – not going to hap­pen tomor­row either.

If the lat­ter hap­pens and you’ve sad­dled your­self with a big fat mort­gage, you could wind up a pris­oner in the home you used to love, a home which is now too far from your new job, too small for your grow­ing fam­ily or too expen­sive with your spouse out of work.

This is the very real risk fac­ing peo­ple who leap into a red-hot hous­ing mar­ket with a dream, a 5% down pay­ment and very lit­tle savings.

Com­ment: No, it is a risk that you are sug­gest­ing – against all evi­dence to the con­trary – might hap­pen. It is not real at all.

While not a pre­dic­tion, a 15%-plus cor­rec­tion in mar­kets like Toronto and Van­cou­ver is a def­i­nite pos­si­bil­ity. And that means fringe buy­ers who put down the min­i­mum – and stretch their amor­ti­za­tion to the max­i­mum – are tak­ing a Vegas-style gamble.

Com­ment: Van­cou­ver, yes, they are already down some 6%. But they are also 35% higher than Toronto. With com­pletely dif­fer­ent cri­te­ria. A drop of any amount is not likely at all in Toronto. The evi­dence is com­pletely against it. We have 100–110,000 peo­ple mov­ing here each year – plus those mov­ing out of the fam­ily home, or out of res­i­dence. There are 50,000+ new house­holds in Toronto every year. And they all need some­where to live. Mort­gage rates are not going up that much – remem­ber we had more sales and tons of bid­ding wars in 2007 when rates were 6.5–6.75% – dou­ble today’s rates. A jump from 3.29% to 5.29% only raises the aver­age mort­gage by $500/month. The aver­age Toronto buyer(s) have an income of $125,000 and ask for a loan of $262,000. Hardly a dis­as­ter in the making.

A hypo­thet­i­cal sit­u­a­tion shows what might hap­pen if you bought a $300,000 house with 5% down and a 30-year amor­ti­za­tion. (The aver­age pur­chase price for a first-time buyer is about $295,000, accord­ing to national fig­ures from mort­gage insurer Gen­worth Finan­cial Canada.)

This sce­nario assumes a 15% drop in home value over three years and flat prices for another six or more years. (It also assumes you make no mort­gage pre­pay­ments, pay a 2.95% default insur­ance pre­mium – as required by law, and incur roughly 6.5% in liq­ui­da­tion costs, which include real­tor fees, legal fees and dis­burse­ments, mort­gage dis­charge fees and penal­ties, repairs and stag­ing, etc.)

In this hypo­thet­i­cal sce­nario, if you wanted to sell your house after five years you’d owe at least $16,500 more on your mort­gage than you could get from the sale.

Com­ment: The more likely sce­nario is much dif­fer­ent. You buy for $300,000 today and price appre­ci­a­tion slows to 5% or less per year. After 5 years at 5% annu­ally, your prop­erty is worth just under $383,000. With bi-weekly pay­ments at 3.29% you pay your mort­gage down to $255,000 (includ­ing CMHC insur­ance and all that). So now you have a prop­erty worth $128,000 more than you paid for it. To sell it, you likely pay 1% to the list­ing agent and 2.5% to the buyer’s agent – plus HST. That is $15,345.40 plus legal fees of about $1,600. There would be no mort­gage penal­ties as it is the end of your 5-year mort­gage term. So you net around $111,000 – not bad at all! Even with 0% appre­ci­a­tion over the 5 years, you can take $83,000 off the prof­its and you still come out $18,000 ahead. This stu­pid dis­as­ter sce­nario is so unlikely… you just will not end up owing $16,500. You just won’t.

So here’s the sim­ple point: If you have to stretch your­self finan­cially to buy a new home, you’re prob­a­bly not ready to trade in your land­lord for a lender.

Com­ment: We are all stretched to buy! Unless we win the lot­tery… The aver­age Toronto price is $517,000 – which means a $26,000 down pay­ment. Plus legal fees of $1,600. Plus land trans­fer tax of $13,000 in the 416 ($6,800 in the 905). So to buy the aver­age prop­erty in Toronto with only 5% down means you need $40,000 cash on hand. That is a lot of money for most peo­ple! Heck, at $100/week it will take almost 8−1÷2 years to save up that much. So let’s not make it seem like a big­ger deal than it is. For the aver­age buyer, they are putting down $40k – they have money, they are not strapped. And if you are buy­ing an $800,000 house with 20% down, you will need almost $190,000! Strapped indeed!

If you do press for­ward with just 5% down, be pre­pared to stay in your home a while – poten­tially a long while.

Here’s what some peo­ple with expe­ri­ence say about 5% down mortgages:

• “5%-down mort­gages are geared to some­one that’s more than a few years into their career, with path for advance­ment and income increases; some­one who has a sav­ings plan; and some­one who’s demon­strated that they’re han­dling credit respon­si­bil­ity and are well below nor­mal debt ratio lim­its. If a borrower”s house was worth less than their mort­gage debt, things like job loss, pay cuts and over­spend­ing would only exac­er­bate the risks and fur­ther limit their options.” — Mort­gage spe­cial­ist Marc Ffrench, Royal Bank of Canada

• “The clients putting 5% down on a $600,000 house with a high debt ratio are the ones you espe­cially worry about. These are prop­er­ties where you need two par­ties with six-figure incomes.” — Mort­gage plan­ner Geoff Willis, Domin­ion Lend­ing Cen­tres Origin

Com­ment: And they have it. Young cou­ples buy­ing houses eas­ily have dual incomes in the $120-140k range. One mak­ing $63,000 and the other mak­ing $78,000 is not unusual. The income required to buy a $600,000 house with 5% down is just under $100k. They are not even stretched to qual­ify. Par­ents chip in a bit and sud­denly they have 15% down and pay­ments of $2,267 – about the same as rent­ing a 2-bedroom condo.

• “A 5% mort­gage really isn’t suited to a lot of peo­ple. If you absolutely have to put down 5%, aim to make addi­tional pay­ments every year to amor­tize the mort­gage faster.” — Finan­cial adviser Adrian Mas­tracci, KCM Wealth Management

Com­ment: Sure, we would all like to make extra pay­ments. Most of us are just not that disciplined.

• “You should also have some kind of emer­gency fund – at least three months of liv­ing expenses. Put it at an insti­tu­tion that has not lent you any money because they can some­times use money in sav­ings to off­set (delin­quent debts).” — Mr. Mastracci

Com­ment: Well that just applies to every­one, not just those with 5% down. That quote does not even men­tion down payments…

And by all means, if you can’t make a healthy down pay­ment, be sure you’re finan­cially sta­ble and love your house. There’s a chance you could be in it a lot longer than you think.

Com­ment: You should always buy some­thing you love – it’s your home!

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

Lau­rin & Natalie Jef­frey are Toronto Real­tors with Cen­tury 21 Regal Realty.
They did not write these arti­cles, they just repro­duce them here for peo­ple
who are inter­ested in Toronto real estate. They do not work for any builders.
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