An interesting report was floating around last week about the affordability, or more like the lack of affordability, of homes in eight countries including Canada, US, Britain, Australia, New Zealand, Ireland, Japan, and Singapore.
Unsurprisingly, Vancouver BC was number one in lack of housing affordability compared to 400 cities. Vancouver has median house price of US$1.1 million and a median household income of US$64,000 for an index of 17.1. For comparison, Toronto had an index of 7.5.
Winnipeg, the most unaffordable Manitoba city came through with an index of 3.7. This was found by dividing the median house price of US$256,000 with a median family income of US$70,000.
The researchers suggested affordable housing was defined by an index ratio of 3.0 and below. So, if you had an annual family income of $60,000 then you can afford a $180,000 home. Higher scores in the index ratio indicated higher barriers to affordable housing.
The government and banks use a different formula, but they are in a similar range with recently implemented stricter mortgage lending requirements. The government and banks are concerned about home owner’s ability to meet mortgage repayment requirements, especially if interest rates increase. Under the Total Debt Service Ratio, a maximum of 32% of your family income can go towards the repayment of debt. Car payments, student loans, and other debt quickly diminish the amount of mortgage a family can afford.
Recently, the government issued a directive that banks must use their highest 5 year mortgage interest rate in calculating affordability of payments, even if the mortgage client was receiving a much lower floating rate.
Yesterday, I used an online mortgage calculator to figure out what size of mortgage a $60,000 family income could support. Assuming a 10% down payment, the old rules would allow for a $250,000 mortgage. Under new rules, a $60,000 annual income can only support a $200,000 mortgage now. A more expensive home could still be purchased but would require a much larger down payment.
We have been encouraging our younger clients to consider working a “mock mortgage payment” into their monthly cash flow. The extra $1500 or $2000 per month is deposited into an investment account and left to compound. Not only do they experience the impact of a sizeable monthly cash flow commitment, but they are actively accumulating for an increased down payment. As a side benefit, the greater down payment amount will lower their mortgage default premium. This mortgage default premium (CMHC costs) could be an additional $5,000 to $7,000 fee added to the mortgage principal depending on the size of the down payment.
Why not let the power of compounding interest work for you instead of against you? A $400,000 mortgage would require approximately $2,000 per month payment for the next 25 years. If you saved that same $2,000 per month into an investment account for the next 12 years, assuming a 6% rate of return, you would have $400,000 for your new home.
Details on the actual study can be found here: http://www.demographia.com/dhi.pdf