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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buying a house with a $40 000 salary in toronto

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