In my daily blog reading I came across an interesting discussion on the government debt. There's only so much you can write in a comment, so I figured I'd blog about it myself.
Most personal finance bloggers will proclaim the benefits of being debt free, living below your means, and saving for various reasons. I agree with the sentiment, but I think we need to be careful that we don't over generalize the point here. For example, we save to meet goals, not because we like to stare at money. If you don't set your goals, saving money isn't bad, but it's not really serving its true purpose. Believe it or not, debt can serve a purpose too.
When I was reading in Economics about the government spending and government debt, I found what was not said much more interesting than what was said. There was no talk over whether debt was good or bad, or if the government would be better off in a surplus or not. Reading the textbook, I realized people would be better off running their own finances much more like the government. I know that's probably contrary to everything you've ever heard.
Debt has really developed a bad name over the years. I've had panic attacks in the past, worrying about how I was going to manage to pay my Visa bill or mortgage, so I understand why some people feel that way. Not only that, but while many of us received no real financial advice from our parents, I'm sure most of us heard again and again that debt was horrible. However, I believe this is an over-generalization. Debt can be horrible, but just because it can be, doesn't mean it always is. After all, I'm sure most of you heard the contradiction from your parents that the mortgage was a "necessary evil." I know I did.
The problem is that the word "debt" is being used too broadly. I would agree that consumer debt, which is a form of debt, IS a terrible idea. Consumer debt is debt used to fund the consumption of goods and services for personal or family use. This is what most of us are referring to when we say that all debt is bad. Examples: Any over due credit card balance, car loans, buy-now-pay later loans (appliances, flooring, etc), lines of credit for household items, etc.
On the flip side though, debt can also be a great tool to allow you to invest in opportunities you wouldn't be able to do by your own means. For example, educating yourself with student loans in order to provide your family with a greater income than you're currently receiving. Buying a real estate investment property that translates into higher cash flow. A working capital loan that allows you to start or grow your own business. Of course there are risks involved, but what in life doesn't have risks. There is no guarantee you'll have your job next month, or your so called safe investments will pay off either.
Governments work the same way. They borrow (or should) to expand our future income potential and to improve our economic state. Whereas consumption spending such as health care, schooling, etc. needs to come from our revenue sources. Borrowing for these items (as badly needed as they are) is just a bad idea. Funds for these items can only come by reducing our expenditure in these areas or moving funds from other areas of consumption. Just like we do with our own personal budgets.
Borrowing for the Olympics makes sense because it brings in more tax revenue, future tourism, and greater immigration. Borrowing to house the poor doesn't have that same return unless this leads to increased employment and lowered use of government services.
Have you been lumping all debt together? What are your thoughts on this "great evil"?
Showing posts with label mortgage. Show all posts
Showing posts with label mortgage. Show all posts
Monday, March 15, 2010
Thursday, February 25, 2010
Popping the Vancouver Real Estate Bubble
After my last post, a friend of mine suggested that the housing market in Vancouver is about to burst. As much as I've been curious about the concept of over-inflated housing prices, I've avoided the subject because its been a great mystery to me. With my friend's comment though, I decided it was time to peer into the depths and contemplate the consequences.
The first thing I discovered was that bubbles are often discovered only after they pop. In other words, it's very hard to say with any certainty whether the market is currently in a bubble or not. I'm sure we all get the sense that housing prices in BC are incredibly high, but are they high due to natural supply and demand, or is it far more sinister? Some economists even argue that "bubbles" don't actually exist.
In order for there to be a bubble, people would have to be paying more for a home then they feel it is worth. I have to ask the question. Why would anyone do that?
I think the truth is that many of us have been told that renting is throwing your money away. We feel that we don't have any choice but to pay whatever price the housing market is asking. We also have a consumer driven mentality that pushes us to buy the biggest home we can get. Even if it's outside of our current means.
Vancouver is the most expensive city in the most expensive province in Canada to live in. Yet, most of us don't see moving as an option. We love it here and are willing to pay the price. Even if we grumble about it.
Speculating investors can force the prices up faster than we're doing on our own though. Hopefully the changes recently made by the government will slow this down and not crash the market. I'm not sure the exact percentage of speculators in the Vancouver market or the effect this will have.
Sure there will be corrections as the economy goes through its various ups and downs. Housing shortages and surpluses occur from time to time affecting the market pricing as well. In the end though, I think we're doing this to ourselves and don't really see this as a bubble. At least not one that will burst.
Living here is a choice. As long as we are willing to pay whatever it costs us to live here the prices will continue to rise. Only when we change our choices as a whole, will things change. I wouldn't hold my breath waiting for the world to change around us. If you're waiting for that crash to buy into the market, I predict you will be waiting a very long time.
Our best defence is to live within our means, pay off the mortgage quickly and move up slowly. If you're willing and able you could even move to a more affordable place to live.
If you're not in the market, you might want to wait for a market correction. Buy when everyone else is selling. However, I don't think even then housing here will be considered "affordable."
The first thing I discovered was that bubbles are often discovered only after they pop. In other words, it's very hard to say with any certainty whether the market is currently in a bubble or not. I'm sure we all get the sense that housing prices in BC are incredibly high, but are they high due to natural supply and demand, or is it far more sinister? Some economists even argue that "bubbles" don't actually exist.
In order for there to be a bubble, people would have to be paying more for a home then they feel it is worth. I have to ask the question. Why would anyone do that?
I think the truth is that many of us have been told that renting is throwing your money away. We feel that we don't have any choice but to pay whatever price the housing market is asking. We also have a consumer driven mentality that pushes us to buy the biggest home we can get. Even if it's outside of our current means.
Vancouver is the most expensive city in the most expensive province in Canada to live in. Yet, most of us don't see moving as an option. We love it here and are willing to pay the price. Even if we grumble about it.
Speculating investors can force the prices up faster than we're doing on our own though. Hopefully the changes recently made by the government will slow this down and not crash the market. I'm not sure the exact percentage of speculators in the Vancouver market or the effect this will have.
Sure there will be corrections as the economy goes through its various ups and downs. Housing shortages and surpluses occur from time to time affecting the market pricing as well. In the end though, I think we're doing this to ourselves and don't really see this as a bubble. At least not one that will burst.
Living here is a choice. As long as we are willing to pay whatever it costs us to live here the prices will continue to rise. Only when we change our choices as a whole, will things change. I wouldn't hold my breath waiting for the world to change around us. If you're waiting for that crash to buy into the market, I predict you will be waiting a very long time.
Our best defence is to live within our means, pay off the mortgage quickly and move up slowly. If you're willing and able you could even move to a more affordable place to live.
If you're not in the market, you might want to wait for a market correction. Buy when everyone else is selling. However, I don't think even then housing here will be considered "affordable."
Monday, February 22, 2010
Changes to the Mortgage Rules
Starting April 19th, borrowers will have to qualify for a five-year fixed-rate mortgage even if they opt to apply for a lower variable rate. You will also only be able to borrow up to 90% of the value of your home, instead of the previous 95%. Finally condominium investors will need 20% down to invest instead of the previous 5%.
So, how does this effect us? Well, hopefully it doesn't. Hopefully you've made the decision to live well within your means.
I think variable rate mortgages are a great thing. The reason I like them is because they're generally lower than the 5 year fixed rate, which means I have more money to put towards the principle. That's right I'm still paying the 5 year fixed rate or more when I don't have to. By buying a house I can afford and paying it off quickly I actually end up owning the larger house sooner. All this I discussed in Home Sweet Home.
As for borrowing 95% of your home, I don't really see that as a problem, as long as you're not digging a deeper hole. Debt doesn't have to be a bad word. It all depends on what the money is to be used for. Consumer debt on the other hand is a very bad word. I'll come back to this in a future post. Overall though 90% is not going to hurt us that much and protects the poor decision makers a little from themselves.
Finally, the only way you're making money investing in real estate with 5% down, is if your speculating and flipping. I'm not an investor yet myself, but common sense tells you this is just a bad idea. I saw the effects of this when the housing market crashed here last and people were left owning condos they couldn't afford. Too much risk for me!
I've been researching owning a rental property which I plan to do in the future. Even with 20% down the profit margin is very small. The real money is made only when the property sells and you have to be able to stick it out long term. With 5% down you're using your own money while you wait for prices to rise. If it doesn't happen for years to come, how long can you afford multiple mortgages?
Overall, I think these changes are for the best. They won't cause a major crash or restrict the market too much, which could be devastating to the economy right now. They still allow people to overspend, which while not very smart, is everyone's prerogative. They do prevent the majority of Canadians from going overboard though and seeing as these mortgages are backed by the government, it helps prevent the rest of us from being stuck with their bill.
So what are your thoughts? Is it enough? Should they have done more? Did they do too much?
So, how does this effect us? Well, hopefully it doesn't. Hopefully you've made the decision to live well within your means.
I think variable rate mortgages are a great thing. The reason I like them is because they're generally lower than the 5 year fixed rate, which means I have more money to put towards the principle. That's right I'm still paying the 5 year fixed rate or more when I don't have to. By buying a house I can afford and paying it off quickly I actually end up owning the larger house sooner. All this I discussed in Home Sweet Home.
As for borrowing 95% of your home, I don't really see that as a problem, as long as you're not digging a deeper hole. Debt doesn't have to be a bad word. It all depends on what the money is to be used for. Consumer debt on the other hand is a very bad word. I'll come back to this in a future post. Overall though 90% is not going to hurt us that much and protects the poor decision makers a little from themselves.
Finally, the only way you're making money investing in real estate with 5% down, is if your speculating and flipping. I'm not an investor yet myself, but common sense tells you this is just a bad idea. I saw the effects of this when the housing market crashed here last and people were left owning condos they couldn't afford. Too much risk for me!
I've been researching owning a rental property which I plan to do in the future. Even with 20% down the profit margin is very small. The real money is made only when the property sells and you have to be able to stick it out long term. With 5% down you're using your own money while you wait for prices to rise. If it doesn't happen for years to come, how long can you afford multiple mortgages?
Overall, I think these changes are for the best. They won't cause a major crash or restrict the market too much, which could be devastating to the economy right now. They still allow people to overspend, which while not very smart, is everyone's prerogative. They do prevent the majority of Canadians from going overboard though and seeing as these mortgages are backed by the government, it helps prevent the rest of us from being stuck with their bill.
So what are your thoughts? Is it enough? Should they have done more? Did they do too much?
Monday, November 30, 2009
Home Sweet Home
Last week I discussed home ownership vs renting. This week I wanted to take a look at owning a little bit more.
Someone once told me to buy the largest home you can afford. I didn't really discuss this with him at all, but it certainly was an appealing statement. After all, who doesn't want to own a large beautiful home. Since then though, I've heard some compelling reasons to do the opposite.
The argument is that if you can afford to make the higher payments for the larger home, you can afford to make additional payments to a smaller home. Most banks allow you to make both increased payments every month and a lump sum payment every year (usually on the anniversary). The amount of these prepayments vary from bank to bank, but they all go directly to the principal amount.
The other way to increase your payments on the home is to get a shorter amortization. Meaning you pay your home off in 15 or 20 years instead of the standard 25 years (or 35 for a lot of people in Vancouver).
By paying this less expensive home down faster, you pay less interest and more principal. You can then end up owning the home you originally wanted (or a better one) mortgage free faster.
Stealing some number from a seminar I just had with Doug Fordham, CA, here's an example. Although the number are a little low for the Vancouver area. For simplicity it ignores housing value increases.
If you have $20,000 down and can afford $1,500 per month you can either purchase a $250,000 home with a 25 year amortization or a $175,000 home with a 12 year amortization. If you choose the $175,000 home after 12 years you're mortgage free and can then sell the home and then buy the $250,000 home. It would then only take you 5 years to own the $250,000 home. 8 years sooner than buying it directly. You can then either move to a bigger home again or invest the difference. Either way, you are way ahead by not buying the largest home you can afford.
The other nice thing about buying a home that is more affordable, is that you don't have to panic when interest rates rise 1%. Which also means you can take advantage of choosing a variable rate interest rate. Or, if you're not comfortable with going variable at least you can choose a shorter term.
The Wealthy Barber Recommends a 5 year fixed rate and it is one of the only things I disagreed with in the book. According to Dr. Milevsky's Research Findings, choosing a variable rate mortgage would have saved consumers $20,000 in interest payments over 15 years (based on a $100,000 mortgage). It also states, consumers would have been better off borrowing at prime rate (variable) compared to a 5-year fixed rate 89% of the time.
With Variable your mortgage is generally lower than the fixed rate too. So if you pay the same as you would have with fixed you end up paying more of the principal down every month.
Couple other things to consider when you are purchasing a home. If you put less than 20% down you will have to get a high ratio mortgage, which means you have to pay for CMHC insurance. Also, you may want to look at the different mortgage options available. Right now I'm looking at the RBC Homeline plan. It's a mortgage with a line of credit (LOC). As you pay down the mortgage, the room on the LOC automatically increases. So you don't have to go beg for money at the bank when you need it later.
Something I seriously considered and ran the numbers on over and over again was moving. BC is the most expensive province to live in, in all of Canada. Over $200,000 more to live in Vancouver than Calgary or Toronto for example (the closest cities in pricing to us). BC in general is $100,000 more than any other province.
However, we decided we love BC too much to move. Living in BC is a choice though and we recognize that it has a cost. So while we could own a large single detached home 20 minutes out of Ottawa, we've decided we'd rather buy a town home and stay here in Surrey, BC. The cost for the two homes is about the same. Now that I recognize that as a choice though, I'm not resentful about owning a town home when I'd rather have a detached home. Like I said before, it's all about the choices we make.
Someone once told me to buy the largest home you can afford. I didn't really discuss this with him at all, but it certainly was an appealing statement. After all, who doesn't want to own a large beautiful home. Since then though, I've heard some compelling reasons to do the opposite.
The argument is that if you can afford to make the higher payments for the larger home, you can afford to make additional payments to a smaller home. Most banks allow you to make both increased payments every month and a lump sum payment every year (usually on the anniversary). The amount of these prepayments vary from bank to bank, but they all go directly to the principal amount.
The other way to increase your payments on the home is to get a shorter amortization. Meaning you pay your home off in 15 or 20 years instead of the standard 25 years (or 35 for a lot of people in Vancouver).
By paying this less expensive home down faster, you pay less interest and more principal. You can then end up owning the home you originally wanted (or a better one) mortgage free faster.
Stealing some number from a seminar I just had with Doug Fordham, CA, here's an example. Although the number are a little low for the Vancouver area. For simplicity it ignores housing value increases.
If you have $20,000 down and can afford $1,500 per month you can either purchase a $250,000 home with a 25 year amortization or a $175,000 home with a 12 year amortization. If you choose the $175,000 home after 12 years you're mortgage free and can then sell the home and then buy the $250,000 home. It would then only take you 5 years to own the $250,000 home. 8 years sooner than buying it directly. You can then either move to a bigger home again or invest the difference. Either way, you are way ahead by not buying the largest home you can afford.
The other nice thing about buying a home that is more affordable, is that you don't have to panic when interest rates rise 1%. Which also means you can take advantage of choosing a variable rate interest rate. Or, if you're not comfortable with going variable at least you can choose a shorter term.
The Wealthy Barber Recommends a 5 year fixed rate and it is one of the only things I disagreed with in the book. According to Dr. Milevsky's Research Findings, choosing a variable rate mortgage would have saved consumers $20,000 in interest payments over 15 years (based on a $100,000 mortgage). It also states, consumers would have been better off borrowing at prime rate (variable) compared to a 5-year fixed rate 89% of the time.
With Variable your mortgage is generally lower than the fixed rate too. So if you pay the same as you would have with fixed you end up paying more of the principal down every month.
Couple other things to consider when you are purchasing a home. If you put less than 20% down you will have to get a high ratio mortgage, which means you have to pay for CMHC insurance. Also, you may want to look at the different mortgage options available. Right now I'm looking at the RBC Homeline plan. It's a mortgage with a line of credit (LOC). As you pay down the mortgage, the room on the LOC automatically increases. So you don't have to go beg for money at the bank when you need it later.
Something I seriously considered and ran the numbers on over and over again was moving. BC is the most expensive province to live in, in all of Canada. Over $200,000 more to live in Vancouver than Calgary or Toronto for example (the closest cities in pricing to us). BC in general is $100,000 more than any other province.
However, we decided we love BC too much to move. Living in BC is a choice though and we recognize that it has a cost. So while we could own a large single detached home 20 minutes out of Ottawa, we've decided we'd rather buy a town home and stay here in Surrey, BC. The cost for the two homes is about the same. Now that I recognize that as a choice though, I'm not resentful about owning a town home when I'd rather have a detached home. Like I said before, it's all about the choices we make.
Monday, November 23, 2009
Throwing Away Your Money
I used to be quite convinced that renting was just throwing your money away. Over time though, I've learned that everything is not quite so black and white.
I like what was said about it in The Wealthy Barber. It states that shelter is a necessity and there are only two ways to get it. You either rent or you own. It's no more throwing away your money than buying groceries or clothes.
If you think of owning as an investment, like most investments, you need to be in it for the long term. Prices fluctuate, there are market corrections, and in the short term the value of your home could decrease. So one obvious time where renting makes the most sense is when you don't plan to live in an area for very long. Also, sometimes the area you want to live in might not be a great investment area. So you can't count on the home increasing with value or increasing with a decent return on investment.
So like everything else you need to evaluate whether renting makes sense for you and for your situation. Regardless of owning or renting, you don't want to spread yourself too thin. So, if you can't afford to own, Don't Do it!
Now that I've said that, given the right circumstances, I still see more benefits in owning over renting for most people in most normal circumstances.
The biggest argument I've ever heard for renting, is that you can invest the money you save by renting. That is assuming that renting is cheaper of course, which it probably will be if you put less than 20% down. To make a fair comparison of rent to mortgage you need to add the maintenance costs and/or strata fees to the mortgage. So if for example you save $100/month by renting you could then invest that difference.
While I think it's theoretically possible to make more money renting and investing the difference, I haven't seen it in practice. The problem with that theory is that you need to be able to make more money than the increase in the value of a home would have been.
The magic number everyone seems to like to use for housing price increases is a 6% per year increase on average. Of course the real number will vary drastically based on a number of factors including location. But, for arguments sake, let's assume that 6% is correct for you. It almost seems logical that if you could earn more than 6% on an investment (say 8%) you'd be better off renting. The problem is that this doesn't take into consideration the 6% is on the total property value not just your personal investment.
Let's say you put $7,250 down on a $145,000 condo. The following year the value goes up by 6%. That's 6% on $145,000, not $7,250. That's $8,700 which is more than 100% increase on your investment. Before you say I ignored the interest payments to the mortgage, I haven't really. Ignoring the equivalent in rent which you'd have to pay as your alternative, you paid $7,250 plus 100 more per month. Even then, you invested $8,450 for an increase of $8,700.
In my case I put nothing down and the value of my condo has increased by about 41% in 4 years. Now that's a higher than normal growth and it was luck and not skill on my part that I got in when I did. There is no investment I could have made that would have gotten me the same growth if I had invested it elsewhere. None that I know of anyhow!
Some other benefits I find to renting over owning:
As long as you don't experience sky rocketing interest rates, your payments will generally remain unchanged. Whereas rent will continue to increase and close that $100 gap. When you do sell, you also get some if the rent equivalent money back which would never happen with renting. Or if you stay put and don't move, eventually your mortgage is paid off, all you have left to pay is the maintenance fees and taxes. That certainly leaves you with more money to invest than the renter at that point.
Even without selling you build up equity in your home. Equity is the difference between what your house is worth and what you owe. So another advantage is that you can borrow against this money. Like anything this can get you into trouble too, so you need to be careful. Using this money allowed me to get out from a debt burden I couldn't have done without selling my place.
Another example of using the equity would be if you needed to make repairs in order to sell, but couldn't afford it until after it was sold. Also, at some point in the future I'd also like to purchase a second home for and investment and this is likely the best way for me to have the down payment.
So while rent is a valid option for providing shelter and might be the best option for some people, I still see more benefits to owning in the long term. Hopefully this helps someone. If not, I still enjoyed getting my thoughts written down somewhere. Feel free to correct me on anything you think I went astray on.
I like what was said about it in The Wealthy Barber. It states that shelter is a necessity and there are only two ways to get it. You either rent or you own. It's no more throwing away your money than buying groceries or clothes.
If you think of owning as an investment, like most investments, you need to be in it for the long term. Prices fluctuate, there are market corrections, and in the short term the value of your home could decrease. So one obvious time where renting makes the most sense is when you don't plan to live in an area for very long. Also, sometimes the area you want to live in might not be a great investment area. So you can't count on the home increasing with value or increasing with a decent return on investment.
So like everything else you need to evaluate whether renting makes sense for you and for your situation. Regardless of owning or renting, you don't want to spread yourself too thin. So, if you can't afford to own, Don't Do it!
Now that I've said that, given the right circumstances, I still see more benefits in owning over renting for most people in most normal circumstances.
The biggest argument I've ever heard for renting, is that you can invest the money you save by renting. That is assuming that renting is cheaper of course, which it probably will be if you put less than 20% down. To make a fair comparison of rent to mortgage you need to add the maintenance costs and/or strata fees to the mortgage. So if for example you save $100/month by renting you could then invest that difference.
While I think it's theoretically possible to make more money renting and investing the difference, I haven't seen it in practice. The problem with that theory is that you need to be able to make more money than the increase in the value of a home would have been.
The magic number everyone seems to like to use for housing price increases is a 6% per year increase on average. Of course the real number will vary drastically based on a number of factors including location. But, for arguments sake, let's assume that 6% is correct for you. It almost seems logical that if you could earn more than 6% on an investment (say 8%) you'd be better off renting. The problem is that this doesn't take into consideration the 6% is on the total property value not just your personal investment.
Let's say you put $7,250 down on a $145,000 condo. The following year the value goes up by 6%. That's 6% on $145,000, not $7,250. That's $8,700 which is more than 100% increase on your investment. Before you say I ignored the interest payments to the mortgage, I haven't really. Ignoring the equivalent in rent which you'd have to pay as your alternative, you paid $7,250 plus 100 more per month. Even then, you invested $8,450 for an increase of $8,700.
In my case I put nothing down and the value of my condo has increased by about 41% in 4 years. Now that's a higher than normal growth and it was luck and not skill on my part that I got in when I did. There is no investment I could have made that would have gotten me the same growth if I had invested it elsewhere. None that I know of anyhow!
Some other benefits I find to renting over owning:
As long as you don't experience sky rocketing interest rates, your payments will generally remain unchanged. Whereas rent will continue to increase and close that $100 gap. When you do sell, you also get some if the rent equivalent money back which would never happen with renting. Or if you stay put and don't move, eventually your mortgage is paid off, all you have left to pay is the maintenance fees and taxes. That certainly leaves you with more money to invest than the renter at that point.
Even without selling you build up equity in your home. Equity is the difference between what your house is worth and what you owe. So another advantage is that you can borrow against this money. Like anything this can get you into trouble too, so you need to be careful. Using this money allowed me to get out from a debt burden I couldn't have done without selling my place.
Another example of using the equity would be if you needed to make repairs in order to sell, but couldn't afford it until after it was sold. Also, at some point in the future I'd also like to purchase a second home for and investment and this is likely the best way for me to have the down payment.
So while rent is a valid option for providing shelter and might be the best option for some people, I still see more benefits to owning in the long term. Hopefully this helps someone. If not, I still enjoyed getting my thoughts written down somewhere. Feel free to correct me on anything you think I went astray on.
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