Housing Market: A House of Cards

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The current housing market is like a roaring ocean. For decades, conventional wisdom has told us that if you buy a house young, you’ll be set for life. However, as housing prices continue to climb to historic levels, it might be time to revisit our hypothesis.

Problem One: The Housing Market

If the rule of thumb is to buy a house young, what can new home buyers expect?

Well, the average home price in Canada in 2018 was $495,000. The lowest provincial average price was in New Brunswick at $178,000 and the highest was in B.C. at $730,000. In comparison, to offset these expenses, the median Canadian household income is around $71,000.

First time home buyers in Canada average 29 years of age, and their average down-payment is roughly $48,000.

Let’s assume that the average young Canadian is earning the median income in Canada and can afford to set aside the recommended 10% per year. If their savings of $7,100 each year can earn 6% interest it will still take them nearly 6 years to save the $48,000 down payment.

Not to mention, in 6 years time, housing prices will probably increase even more. Unless, of course, something changes.

In our previous example we made some large assumptions. Most Canadians, specifically the younger generations, are not saving anywhere close to 10%. In addition, most are earning less than the median salary of $71,000. For more information on wages and savings, you can read: You are Being Underpaid, and Canadians Lack Personal Savings.

Problem Two: Lenders Are Getting Greedy

As you know, lenders view a borrower’s credit history as the primary indicator for mortgage approval/denial. However, as the heading suggest, lenders are becoming more greedy and are looking for new ways to increase lending capacity. Most likely these changes will not be for the betterment of the economy in the long-run, as we will see an increase in subprime borrowers in the marketplace.

The main assessment for borrower creditworthiness in the US is their FICO score (credit score). Banks and other lenders are now wanting to incorporate seemingly bizarre information into their credit tests. Some of the information includes; magazine subscriptions and phone bills.

You may be asking, “Why?”. Well, banks and other lenders are arguing that any new potential borrowers don’t have traditional borrowing backgrounds. Therefore, incorporating these subscription and bill payments will boost the young borrowers score. They are also arguing that one reason a borrower may not have good credit is because they may be paying for things in cash or be new comer to the U.S. The banks would also like to incorporate these criteria into their assessments.

These potential changes mean that banks are beginning to target nearly 109 million new borrowers. 53 million which have no credit score, and 56 million which have subprime credit scores.

As they say, history repeats itself. Remember the no-doc loans and sub-prime CDO’s before the last bubble. – Hopefully the banks learn from their previous mistakes and really think about what they are proposing. It seems that lenders also forget what happened in 2008. – This is another case of recency bias.

Note: This section is based on US information, but can easily translate to a potential future for Canada.

Problem Three: Fannie Mae and Freddie Mac

No. These aren’t names of some new pop artists. Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp) are the two main arms for the US federal government that deal with the housing market.

Back in 2008, both Fannie and Freddie experienced heavy losses and were placed on “conservatorship”. The US government was forced to bail them out by giving them a total of $190 billion. This was the necessary amount of tax payer money required to keep them afloat.

A mere 4 years later, Fannie and Freddie were seized by the US treasury in order to avoid yet another financial catastrophe. You would think that they would learn from experience. However, the Senate Housing Committee and Trump Administration both believe that “The housing finance system is worse off today than it was on the cusp of the 2008 financial crisis.”.

Conclusion

With lenders desiring the pursuit of “non-traditional” borrower’s as an expanded market cap, we can expect that home prices will continue to rise. This, coupled with the fact that many believe the housing finance system is worse off today than in 2008, it’s easy to conclude that we could be on the cusp of another bursting bubble.

P.S. Many people believe that purchasing a house is a great investment. Although the money you might make from the sale of a house may be considerable, a house should never be viewed as an investment. Stay tuned for a future blog post on this topic.

Sources

https://www.birchgold.com/news/us-housing-finance-worse-off-today-than-in-2008/

https://www.globalpropertyguide.com/North-America/Canada/price-change-10-years

https://www.statista.com/statistics/604228/median-house-prices-canada/