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What is it about young people and real estate these days? I don’t freakin get it! I am in my 20s, good job, steady pay, could probably put a decent amount of cash down on a house.

But here’s the thing: I would never buy a stock at a high point so why on earth would I do this with a house? And yet there are literally hundreds of young couples buying up real estate every day. This is nuts! And they aren’t just buying what they can reasonably afford. No, they are purchasing the most expensive property the bank will let them have! I can’t say I really blame banks or brokers for pushing them to their limit (they get paid more) but I’m really amazed that none of these people have any sense of financial responsibility.

Seriously, ask these people if they would put 80% of their money into a single stock and they would laugh at you. So why the heck would you do it with a house?

I guess it’s pretty obvious how I feel about it…but I know this: these people will be in a whole heap of trouble once interest rates start going up.

But tell this to someone who has recently purchased property and you will get rude and unfounded remarks.

Real estate always goes up!’
‘Canada didn’t create sub-prime mortgages so our market won’t crash!’
‘Who cares if interest rates go up? I will be making more by then!’

Ya right…like we’ve never had a real estate crash in Canada before. Sub-prime mortgages? I seem to remember the Canadian government allowing 40 year no money down just a couple years ago.

As for the last statement…well, if you think your salary will pace the rise in interest on a 400k+ mortgage I advise you to look at current job futures and our unemployment rate.

OK, let’s have a quick look at some numbers.

Assumptions:

– Purchase $400,000 single family home
– 5% down over 35 years (the most common amortization in Canada right now…yes I know this is changing, too little too late, don’t get me started)
– Current 5 year fixed mortgage rate: 3.99%

Current monthly payment: $1672

If interest rates rise a mere 1% in 5 years (highly unlikely) your monthly payment will now be $1903
A 2% increase and your monthly payment will be $2145
A 3% increase: $2398
A 4% increase: $2660

It is a fair assumption that we will begin to see interest rates rise in the middle of 2011. If the central bank were to raise it at only 0.25% per quarter, you would still be looking at an increase of 4-5% over the next 5 years.

Now tell me, in 5 years do you see your household income being $1000+ per month more than it is now? That’s a $12000 salary increase (or $6000 each). Not outrageous, but not guaranteed either. And what if you have kids in the next 5 years? A car loan? Medical problems? And if there’s one thing I know about my 20 something housing obsessed friends, they will certainly have some huge reno loan payments from useless granite counter-tops they purchased.

What’s more, on a mortgage amortized over 35 years you pay almost nothing towards the principle! So let’s say your house does go down in value, now you still owe the entire principle plus the difference in equity loss to the bank just to close on the sale! Let’s not forget about closing costs, that’ll tack on a few thousand as well. And you think it will be easy to sell a house in a negative market? Just ask an American, I think the average time a house sits on the market right now is greater than a year. Compare that to your average investment; if you get nervous you can press the sell button and have all that money back tomorrow.

Call me a tight wad (I prefer a realist), but I wouldn’t touch real estate with a 10 foot pole right now.

‘So what, you’re just gonna rent and pay someone else’s mortgage forever?’

Comments like this are such a joke…Ya, I am gonna rent, for the next 5-7 years anyway. If I can rent a 2 bedroom condo in downtown Calgary for $1100/month with heated underground parking, a gym, a grocery store 4 blocks away and my work a mere 20 mins on foot, ya, I’ll stay here until I need the space…ie. children, 5+ years at least!

So while these young couples are living house poor, putting every last dime into their mortgage, renos, repairs, utility bills, property taxes, maintenance/strata fees, I will be putting 30% or more of my income into my liquid investments.

Housing in Canada will go down. I am as sure of this as I am that $100 oil will be a reality by the end of 2011.

But alas, I could be wrong. Maybe I should be purchasing a Crack Shack (or Mansion). Maybe the real estate pumpers are right and I will be ‘priced out forever’. But if you believe anything most financial analysts have to say, or the likes of Garth Turner for that matter, I will be coming out ahead.

Take home points:

  • Like it or not, interest rates are going up.
  • In five years you will have paid virtually nothing towards the principle on a 35 year mortgage.
  • Real estate is not liquid.
  • There is nothing wrong with renting.

Did you honestly imagine the first house you would buy would be bigger than the one you grew up in?

 

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