Alberta Canada Foreclosures Personal Finances

Interest rates and defaults

Continuing our consumer debt series, and today we’ll take a look at how interest rates play into things. So lets jump right in and start with interest rates and bankruptcies.

Here I’ve overlayed interest rate and the national and provincial bankruptcy rates. What we can take from this graph is that the gradually decreasing interest rates haven’t had any noticeable impact on bankruptcy rates. The one thing that does stand out is the dramatic spike in interest rates in 1994/1995, which coincided with the start of a more gradual spike in bankruptcy rates which eventually topped out in 1997.

It’s hard to say if, or how much, of a causal relationship may exist between these happenings, but as we discussed in my last post, people are increasingly likely to default on loans early in their terms, particularly when the rates charged are high. So the rise in bankruptcy rate could be a remnant of people taking on debt during the interest rate spike… or it could be nothing. Worth noting anyway.

Moving on, now we’ll hit on interest rates and mortgage arrears. This data goes back one more year, and here we can see there was an additional spike in interest rates in 1991… and like the bankruptcy rate, we can again see an arrears spike lagging, and topping out about two years after the interest rates did.

Again this could be a coincidence, but such a relationship would seem rather intuitive and seems to show abrupt interest rate spikes may contribute to later spikes in loan defaults. The slow decline of interest rates don’t appear to have a major effect, but rapid increases do seem to be a noticeable driver.

So, obviously in our current low rate environment this could spell trouble ahead as rates are almost assuredly to rise at least back to more historical norms. That graph is also another reminder of just how historical norms have been and how fortunate borrowers have had it for the last decade. 7.5% appears quite moderate over the last 20 years (and if we went back 30 it would look even better), but if we suddenly found ourselves in that situation tomorrow, havoc would be wreaked, and not just on the real estate market.

Finally, cause I have the data and went to the trouble of making the graph, we’ll take a look at interest rates and average bankruptcy deficiency We hit on this last week, but for a quick and dirty explanation, deficiency is the surplus of liabilities over assets upon filing for bankruptcy.

This data goes back much further, all the way to 1976 and the series was annual. Obviously what catches everyone’s eye is the big spike there in the early 80′s. Seems there were a whole lot of bankruptcies that included foreclosures during that spike, especially in Alberta.

Beyond that period there doesn’t appear to be as much a relationship between the measures as the ones we’ve discussed earlier. But as I discussed last week, most of the time the majority of bankruptcies do not include foreclosures, so that isn’t surprising. While we don’t have foreclosure numbers going back to the early 80′s, the deficiency measure would seem to indicate there were a whole lot of them.

Anyway, hope you guys found this interesting, a little macroeconomic food-for-though to chew on this weekend. Take it for what it’s worth.

Alberta Foreclosures Macroeconomics Personal Finances


Hope everyone enjoy their Thanksgiving long weekends, and filled up with turkey and complex carbohydrates.

In the comments section of last weeks post on consumer debt someone referenced these stats on bankruptcies/insolvencies in Canada. I managed to find their historical bankruptcy numbers, but not the proposal and total insolvency stats (insolvencies = bankruptcies + proposals).

So, we’ll take a look at the bankruptcy numbers today, and rather then do one monster post I’ll just do a series and in coming days and weeks I’ll do further comparisons between consumer debt, bankruptcies and foreclosures.

Rather then just quoting the hard figures, most of these measures have been derived to give a better historical context. This is a figure of the number of consumer bankruptcies per 1,000 people in Alberta for any given year. Also included the long term average and median figures for comparative purposes, and a projection of what the 2009 figure will be based on the numbers through August and long-term seasonality.

As we can see, through 2008 we were still in the average range overall, but actually quite low when compared to the prior 20 years (given the shift there must have been some kind of change in measurement and/or legislation around 1990). During the boom period we saw bankruptcy figures fall, but are expected to spike back up this year to pre-boom levels.

It is also interesting to look at the historical figures. For example, we’ve talked here often about the early 80′s recession and have heard the stories about the devastation felt by residential real estate. We can see bankruptcies did double from the boom days in the 70′s to the bust in the early 80′s… but the rate stayed constant right through the rest of the 80′s, no discernible spike as one might expect.

Then in the early 90′s we see the rate climb from 1.0 to 2.25… this also coincided with a recession (though minor compared to a decade earlier), but curiously in the mid 90′s the rate took off again and topped out above 3.5 after the recession had already played itself out.

From what we know about home prices, they had a significant drop in the early 80′s, and minor one in the early 90′s, but were stagnant in the mid-90′s. So, it would seem any relationship between consumer bankruptcies and real estate is probably not closely tied to bankruptcy rate.

Just some food for thought, here is the year-over-year change in bankruptcy rate. Interesting to note that based on our current pace, 2009 will have the highest increase ever. No small feat considering it was not exactly low going in. While probably not directly effecting real estate, it is a rather damning statistic for the Alberta economy as a whole.

Beyond just the number of bankruptcies, the stats also include sets on the assets, liabilities and deficiencies (assets less liabilities). I adjusted all these for inflation (2009 dollars) for comparative purposes and then divided that number by the number of bankruptcies to get a ‘per bankruptcy’ figure.

Here we can really see the effects of the early 80′s recession. While the rate was not so high, there was a HUGE difference in the sums of money per bankruptcy, and that’s likely a sign there there were a lot more foreclosures involved… where as it appears in most years the vast majority of bankruptcies involve those that do no own real estate.

When it topped out in 1984 there was an (inflation adjusted) average of about $237,000 worth of liabilities (very close to the inflation adjusted average real estate price at the peak of that boom, coincidence?!), to only about $60,000 worth of assets. The figures at play between 1982 and 1986 completely dwarfs any figures before or since.

Here is another graph that somewhat combines the two prior. It overlays the rate over the average deficiency (I included nominal and real dollars just so you can see for yourselves the effects of inflation).

Here we can see that the sums involved are really not related to the number of people defaulting. Through from 1991-2001 despite the rate being at all time highs, the average person who filed for bankruptcy was less then $10,000 in the hole.

So we can fairly safely conclude that in those years that vast majority of those going bankrupt were not home owners, or in any danger of becoming one, so the rate itself is probably of little value in predicting foreclosure rates.

What is a better indicator of foreclosure trouble is the sums involved.

The 80′s were remembered as disastrous, and the deficiencies witnessed then reflected that. We had a slight hiccup in the early 90′s, and we can see a corresponding blip in 1990. The more people that are foreclosed upon, the higher the numbers will skew.

That we have been tracking upwards the last few years could be a warning of things to come, but as we’ve discussed here, the levels of non-mortgage debt carried have also taken off of late too, so we must take that into the equation.

It will be interesting to see what the numbers end up looking like in 2009, as I could not do any projection for the deficiencies and that is the number we’re most interested in for our purposes.

Canada Macroeconomics Personal Finances

Consumer debt

I got my Wild Cherry Diet Pepsi, and I got my Black Jack gum here, and I got that feeling… mmm that familiar feeling that something rank is going down up there. Yeah, I can smell it. I can almost taste it.

Summer is gone and it’s fucking snowing again!

Alright, so you can’t really smell snow. Give me a break, I’m working on a theme here!

Anyway, as you may have deduced by that I’d done as many posts in the five days as I had in the prior month, my little month from hell has ended and I now have more time to dedicate to the all important business of blogging.

Today I think we have a really interesting one, not so much directly related to housing, but moreso to the greater socio-economic front… that being, consumer/household debt.

Statcan has some good data sets on such things, here is a link to the one I used. Actually that one is slightly more up-to-date then the set I used, it’s up to October where as the data I used was only up to May… but one was free (thanks in no small part to the university never deactivating my database access even years after convocation), whereas the other costs $43, which would effectively increase this blogs budget infinitely, and would provide essentially no perceptible difference. I digress.

Actually that data only gives you the total debt, I then divided that by the population at any given time (available here), to come to a per capita level of credit which would be more relatable. Could have also done it on a per household basis, but I could only find one data set for that and it only went back to 1997. It would just be a function of per capita anyway though, so it’s all the same.

As I’m sure you noticed, there are three lines. The green one in the middle is mortgage debt, relating to the purchase of residential housing. The yellow line, is consumer debt, things like credit cards, lines of credit, automobile loads, etc. Finally there is the blue line which they call “Household Credit,” which is the sum of mortgage and consumer debt.

The above graph is of nominal values. As those of you who follow the blog knows, nominal values are not terribly useful when talking about long term comparisons, so lets adjust it for inflation.

There, that’s better… and a little bit scary. As we’ve discussed before incomes have been fairly flat for the last 30 years when adjusting for inflation, so to see household debt has increased 3x in the last 25 years since the last big boom/bust cycle.

This isn’t all together surprising, as we have also discussed how real estate prices have increased faster then the rate of inflation throughout recent history anyway, and residential mortgage debt makes up the majority of total household debt.

What is more alarming is how consumer debt has taken off, particularly in the last 15 years, where it appears to be growing exponentially. Like mortgage debt, this is no doubt linked to the decline of interest rates over the last 25 years.

The current recession has done nothing to quell Canadians thirst for debt, as they continue to rack it up at a record pace thanks to the rock bottom rates we’ve seen the last six months, even while Americans have pulled back at the same time.

The question now is that rates have for all intents and purposes reached their absolute bottom, they must now go up. The degree to which that will happen is yet to be seen, but once it happens it will contract the levels people are capable of carrying… which would have a devastating effect on not just real estate values, but the economy as a whole.

Here is a look at a bit of a different angle of the numbers, this the year-over-year change. Much more volatile, but we can also see, the forms of debt tend to track together. When consumer debt spikes or dives, so does mortgage debt, to different degrees but strikingly similar patterns.

We also know the last big decline in real estate values came in the early 80′s, and we can see the mother of all troughs. Such a decline in not only mortgage debt, but also consumer debt would obviously have a major impact on the economy, and this would seem to be consistent with has been happening in the United States the last couple years after their housing bubble popped.

So, one would expect that if the same were to happen here in Canada, we would see a big contraction in not just mortgage debt, but also consumer debt, which currently stands at record levels and an extended period of relatively high year-over-year growth.

Exactly what is to come is difficult to say, but there is no doubt that if interest rates were to return to historical norms it could spell big trouble considering the level of debt carried by Canadians.

So, until next time, just look inside yourself and you’ll see me waving up at you… naked… wearing only a cock ring.

Personal Finances

A Contemporary Story – The Sorta Happy Ending

Those you that have been following the blog for awhile, or have browsed the archives, you may have came across my musings on a couple friends of mine (original story, and the update).

Long story short, they bought a spec townhouse in mid 2006 for $200,000. Last October they decided they would be moving to Calgary post-haste and put their place up for sale at $285,000 figuring it would sell in a heartbeat (especially since a year or so earlier their neighbours units were selling for $350-400K). They also put in an offer on a house in Calgary that same week.

Didn’t quite work out that way for them, and after several price cuts and relistings they were still holding it in March and asking price was then sitting at $260,000. Their offer was accepted for the house in Calgary, but fortunately for them the financing requirement saved them as they couldn’t sell and thus the deal fell through. Which takes us to the end of the update I did on them.

The spring continued much the same, no action, and more cuts to the asking price… continued into the summer even. Finally in July they cut it down to $240,000 and it sold two weeks later for $230,000. Everything was finalized last week and they are now free and clear.

They are happy to have it over with, but as needless to say, are licking their wounds after not only getting $50,000 less then they thought they would, but going out of pocket for carrying a vacant property for almost 10 months, then there was the payout penalty.

Frankly they should be grateful interest rates plummeted and goosed the market, or they’d probably still wouldn’t have sold and would be continuing their magic carpet ride to the bottom and negative equity. Fortunately they’re out though, and on the surface ignoring what prices did during the boom, holding a property for three years and selling it for 15% more then you paid is really quite good. Could have been a lot worse.

Of course then you have to figure in all those other costs. The realtor commission takes a big $10,900 bite out first and foremost. Then they get hit with a $9,000 payout penalty because there were still over two years left on their mortgage term.

This should serve as a lesson for all those potential first-time buyers out there who only plan on living in the place for a couple years before trading up… know what you’re getting into and be aware of the penalties for entering into a closed mortage. That lower rate comes with some steep penalties if you don’t play your cards right. These two knew all along they weren’t planning on living there the entire five years, but chased the lowest monthly payment they could get, and it bit them in the ass in a big way.

So, now that 15% windfall only resulted in 5% actually realized. Not quite as impressive.

Of course in their situation, since they immediately moved upon listing, over the ten months they also ate roughly another $13,000 in carrying costs (mortgage interest, strata fees, basic utilities). Which would technically put them in the red, but because of the way they did it you have to figure in even best case they were going to have to carry it for a couple months… so, we’ll say they broke even on the venture.

Not quite the cash cow they envisioned when they listed it ten months ago. The ultimate irony being that is they had listed it agressively in the first place they probably could have sold it right away for $240,000-$250,000 before the market further slid, saved a bunch of carrying costs (though would have suffered a bigger payout penalty), and actually cleared some profit… but the idea of getting their price was too much for them at the time, and they ended up worse off for it.

They’re currently renting down South, but have just signed on to get a custom house built. At least this time they waited to actually sell before committing, and this place they intend to stay in for the foreseeable future. They learned some expensive lessons the hard way, but were fortunate that it came out of unrealized gains and didn’t ruin them.

Those that bought those townhomes at the height of the boom when they were going for $350,000-$400,000 on the otherhand… they’re proper fucked.

Personal Finances

Be careful what you wish for

Of late we seem to be hearing increasingly from people predicting runaway inflation… sometimes almost cheerleading for it. For those who bought at the height of the bubble, this may seem on the surface to be an attractive viewpoint as it could quickly erase the downturn in prices.

I’m not really sure anyone that bought at the top should be quick to embrace heavy inflation though… because there is a nasty flip side to it, and that is interest rates. No matter how high inflation goes, interest rates go higher.

Over the last couple decades, it seems all the rage for fiscal policies to be fighting inflation, keeping it in the 1-2% range whenever possible… as a result mortgage rates have dropped from the double digits down to the 5-8% range for much of the last decade or so.

One must only go back to days of more moderate inflation like the mid-80′s when inflation was around 4% YOY, and interest rates were regularly 11-12%. Even just a return to moderate inflation could spell disaster for many of those first-time buyers who entered during the boom.

The problem lies in that so many people extended themselves to the max to finance these places, and “get in before they were priced out.” To them rates going up a couple points could be too great a cost, much less if they doubled.

Even with the gains in salary that comes with inflation, the interest costs at renewal would be too much. To give you an example, lets say a couple bought a SFH in ’07, and financed $400,000 (which depending on the month might only get you the median home in Edmonton FWIW). 5-year fixed mortgage rates at the time were around 6%, and while they didn’t have a downpayment, at least they were smart enough to do it with 25 year amortization. Their monthly payments would be $2,577, and like many others, they borrowed to the max of what they qualified for, and could afford.

So they’re set through 2012. Lets say that by then inflation has went up to 4% (which historically is quite moderate if not low), but with it interest rates have also shot up to 12%. Now their mortgage is up for renewal, and lets assume the bank is willing to do business with them.

If they want to have their home paid off as planned, their payments will go to $3,960 a month… a 54% increase over what they were paying before. Even with inflation increasing salaries and a raise or two along the way, many wouldn’t be able to swing that.

Even doing a complete refinance and taking the maximum term of 35 years, rather then the 20 they had left, they would still have to pay at least $3,600 a month. More than a thousand a month more then before.

Gawd forbid they were amoung the 67% of first time buyers at the time that had a 40 year amortization. Those poor souls would see their payments jump from $2,200, to $3,920 a month, and they wouldn’t even be able to stretch out the term any longer. They’d also still owe $386,000 on the house.

Ultimately for all the good inflation would do to incomes to increase buying power, interest rates would more then offset that and would actually cause prices to further decline in the short term. At 12%, for the median house to be affordable at $400,000, the median household income would have to be over $160,000 a year… as of 2006 the median household income in Edmonton was $63,000.

At the end of the day, inflation or no inflation, the average household has to be able to afford the average home… otherwise who will buy it? It’s basic supply and demand. Prices may break from affordability from time to time, as we’ve seen, but eventually they will return. They must.

Monthly Stats Personal Finances

Mortgages – Fixed Rate Mechanics

Some of you may recall a month ago I did an entry on why weekly and bi-weekly payments really were not as good as they were cracked up to be. Today I’m going to be my second piece in the mortgage series, this time looking at fixed rate mortgages and their mechanics.

Despite homes being the largest purchases most people make, and mortgages often being a households largest monthly expense, I’m never ceased to be amazed at how many people really don’t have a sound understanding of how they work. So this is my little attempt to shed some light on them.

We’re not going to get into the whole buying high/low thing today, just examine the basic structure of mortgages and how they work.

A lot of people are likely familiar with graphs like the one above if they’ve taken out a mortgage… at least I’d hope they would be, at the very least your bank or mortgage broker should have tried to explain one to you regardless of what type of mortgage you have.

It shows you how over time your equity builds exponentially, while your principle owing correspondingly decreases. The values of these and the proportions paid off can change substantially depending on the variables, but the general pattern remains the same.

The basic gist is that it shows you how little equity you make up in the early years, but as time goes by, more and more of your payments go toward equity rather then interest. Just from this example you can see you make up more equity in the last 9 years then you do in the first 16.

While it’s a pretty pattern, the only number in there that matters to me is the amount owing. The equity really doesn’t mean a lick. All that matters is what you owe.

When your mortgage comes up for renewal, at that point it matters what the bank thinks your place is work matters in relation to what you owe… or if you are selling it matters what someone is willing to pay for it… but the rest of the time, what you think your home is worth, or what your neighbours house sells for, or what the cities median price is, really doesn’t mean a damn thing.

Alright, end of rant. Now lets get on to how 5 year fixed rate mortgages work, and I think the best way to do that is to work through an example. So lets say we purchased an “average residence” in Edmonton in January of 1988, with a conventional 25 year amortization, 5-year fixed terms. These a probably the most popular type of mortgages in Canada.

In January 1988 we bought a house, and paid $77,792 for it, which was the residential average at the time. In reality we would have needed a significant down-payment, but for the sake of this example we’re going to ignore that and say we financed the entire thing. Down-payments are really not material for what we’re doing here today.

So we walk into the bank, finance $77,792 at the going rate for a 5-year fixed of the day at 11.73%. Which result in monthly payments of $804 for the next 5 years… at which point our mortgage comes up for renewal.

Here is a graph kind of incorporating the first two graphs. We have the monthly payments and we see the amount owing declining, telling us what we owe the bank as of each January. We now find ourselves in January of 1993, and owning the bank $74,271… which means we haven’t made up a whole lot of equity in the first five years, less then 5% in this example.

This doesn’t give us all the variables needed to give us our next payment though (ignoring that you can already see in on the chart), for that we need the interest rates…

If the interest rate in 1993 was still 11.73% like it was five years earlier we would still be paying $804 a month… but fortunately for us, interest rates came down!

Now the 5-year fixed rate is 9.47%, we owe the bank $74,271 and now our amortization is down to 20 years… so for the next five years our payments will be $691 a month.

Skip ahead to 1998, our term is up and we do it again, we owe $66,274, rate are down again, now at 6.9% and amortization is 15 years… so we’ll pay $592 a month.

Do it all again in 2003, $51,213 at 6.26% over 10 years… equals $563 a month.

Finally we get to 2008, only five years left, the last renewal! $29,272 owing, the rate actually rose slightly to 6.81% so we’ll be paying slightly more, $577 a month…. but come 2013, that house will be entirely paid off.

What I want to show in the graph is that with our style of mortgages, even with fixed rate ones, every five years your payments will change depending on the going mortgage rate of the time. In our example we were very fortunate in that interest rates just kept on going down, so the monthly payments kept dropping for the most part.

What the fixed rate mortgage shields you from is upward fluctuations of interest rates. As you can see from the graphs, the only interest rates that mattered to us were in the shaded areas, but outside of that they shot up and down quite a bit.

Just take our first renewal for example… if it hadn’t came up until 1994, we would have saved even more since rates dropped over 2 points in that year… but if it had came up in 1995 we would have paid even more since rates spiked that year. So, it can kind of be luck of the draw when your mortgage comes up for renewal, but over time it tends to even out.

The advantage of fixed rate mortgages is that you know what you’ll be paying every month, you don’t have to worry about your payments swinging as they would with a variable rate. The drawback is that you often pay a premium of a point or two more for this stability when you lock in.

So, should interest rates shoot up, at least your protected until your next renewal… should they stay about the same, you lose out because you’re paying a premium for the fixed rate… and should rates go down, you really lose out because you’re not only paying a premium, but you’re paying it on top of a higher rate.

Over the last quarter century we’ve seen rates consistently dropping, which have made variable rate mortgages very attractive… but today, the thing to keep in mind that that we’ve reached a point where rates really cannot get any lower… which means they can only go up, and it’s when rates are rising that fixed rate mortgages are not only safer, but often cheaper.

So it really depends on what you’re comfortable with, and whether you feel the premium you pay is worth it.

The last thing I want to touch on is the differences between Canada and the US when it comes to fixed rate mortgages. As mentioned before, traditionally 25 years has been the normal amortization period, and 5-year fixed the most popular terms.

South of the border, it’s a little different. There, 30 year amortizations are the most common period, and 30 year fixed the most common term. That’s right, with one of those you know exactly what you’ll be paying the entire life of your mortgage.

So using the purchase from our example above, and the going rate for 30-year fixed mortgages in January of 1988, we would have been paying $715 a month (for a better apples-to-apples idea, if the term was 25-year fixed it would have been $737 a month).

So, as you can see, by doing it with traditional Canadian 5-yr terms, we saved a lot of money… but this is because interest rates were dropping. If rates were going up, we would have done a lot worse. Basically it just boils down to that we’re more exposed to market fluctuations here in Canada, and that can be both very beneficial, or very detrimental.

One interesting thing you may have noted is that in 1988, the US 30-year fixed rate is actually lower then the Canadian 5-year fixed rate. This seems counter-intuitive as generally when you go into a bank, the longer the term you ask for, the higher the rate.

TD for example, their current advertised rates are 5-yr fixed at 5.45% and 10-yr fixed at 6.7%. Pretty typical.

Same actually also holds true in the US… this is really more a statement about the rates in the US just being more competitive, cause today you can get a 30-yr fixed from Wachovia for 4.75%… lower then our 5-yr fixed. So if you didn’t think it was bad enough that they can deduct mortgage interest from their taxes, they also get much better interest rates. So, if you’ve ever wondered why our banks are so profitable, there is a big part of the answer, Canadians pay a whole lot more interest.

Historical Prices Personal Finances

Incomes and Interest Rates

I had been wanting to do this for while, but could never find a solid set of data regarding historical incomes in Edmonton… but late last night I finally stumbled upon a Statcan report that was my dream come true.

So today I’m going to take a look at incomes, interest rates and prices over the last 30 or so years here in Edmonton. This may get a bit long and be a bit graph heavy, but their are a lot of different angles to look at, but I’m going to try to narrow things down as best as possible.

To get things rolling lets take a look at this graph (like all the graphs, you can click on the image to get a view of a larger version).

Here we see the median and average economic family incomes for Edmonton from 1976 through 2006 in nominal dollars. A fairly steady, gentle curve up as time goes on. We’ll also note the average always is proportionately higher then the median, but that they track very similar patterns. As I’ve mentioned before, I think median is the more reflective stat, so we’ll be using it rather then the average.

Now the same graph adjusted for inflation (2009 dollars).

It’s striking how relatively flat earnings have been over the last 30 years. It’s also interesting to note this chart picks up in 1976, during the run up of the last big housing boom in Edmonton (as discussed in this entry) and ends in 2006, effectively the run up of the current boom.

Unlike home values which has seen a small growth above inflation, earnings have experienced negligible growth above inflation. You may be asking yourself how we can afford to be paying more for homes when earnings are stagnant… that ties into this next graph.

This graph shows the values of average interest rates on mortgages (5 year terms) in Canada since 1962. As you can see, they have been very volatile and have a huge range. We can also see that historically we’re currently at very low levels… even lower still when you consider todays rates are not represented in the graph (though it is worth noting that in the early-60′s, rates then were in around 7%).

To get back to the earlier question of why we can afford to pay more for homes when earning effectively earning the same income… it’s because interest rates are historically low. As you can see from the graph we’re well below the long term trendline, and have been to varying degrees for most of the last 15 years.

It’s also interesting to note the contrast of interest rates during the last housing bubble to the current one. The last one saw prices increase then hold from about ’73 to ’81… a period when interest rates were climbing. Significantly. Rates were already trending up leading into it, then went from about 10% in ’73 to as high as 22% in ’81.

Numbers like that are unheard of today, credit cards aren’t even into the 20′s! Prices were rocketing up, even when the cost of borrowing was doing the same… compare that to our current bubble when the cost of borrowing was a relatively paltry 6-7%.

Now that we have the interest rates and the prices, we can figure out what income it would take to qualify for a conventional mortgage (25 year amortization) using the 32% Gross Debt Service Ratio (but ignoring taxes and heating costs, so effectively people would actually have to earn more, but for the purposes of this example they’re ignored).

This is unadjusted for inflation. We can clearly see the two bubbles, when the income required for financing blows WAY past the median family income of the city. This was also for Single-Family Homes, the same graph for residential average can be viewed here.

It’s interesting that both bubbles appear roughly similar in that graph, but when we adjust for inflation…

Suddenly that boom in the late 70′s-early 80′s looks massive…. and that big spike it almost entirely due to the staggering increase in interest rates, as prices relative to inflation had largely plateaued from ’76 to ’81. Rising interest kept putting more and more downward pressure on prices, and eventually prices gave as affordability disappeared.

In any case, as we can see, eventually prices got back in line with earnings (interest rates coming down also contributing to that) and stayed relatively close for about 20 years or so… until the current bubble took off. It should be noted, the income data is not as current as the real estate prices, hence they cut out two years early.

Another factor to take a quite look at is interest rates and inflation rates… here is a little graph of that (these are yearly averages unlike the earlier graph of interest rates, which were monthly).

Not surprisingly, they track together. Like interest rates were much higher during the last boom, so was inflation. This revelation also reveals that lowering interest rates would have cushioned the fall during the last bust… so even if you overpaid at least you’re going to see your payments decrease in the future and inflation would be bringing up incomes thus improving affordability at higher prices. This is in stark contrast to where we find ourselves now when the prime rate is already effectively at rock bottom and inflation is minimal if not negative.

Since the 90′s economic policies have been trying to minimize inflation, trying to keep it 1-2% a year when possible… contrast this to the last bubble when inflation was anywhere from 6-12% annually. So, while inflation could go back up to those levels, it would also cause interest rates to go up and these effects would largely offset each other.

Which begs the question, what happens this time?

It’s a good question… because prices are still out of line, interest rates are effectively as low as they can go and inflation currently is negligible (and some are even speculating we may see some deflation)… in this situation, prices are the only thing that can give.

Even in the event of inflation because of all the printing of money, interest rates will inevitably also increase… which will still leave prices as needing to make up most of the difference and financially destroy most who bought during the boom when their mortgage comes up for renewal or are on variable rate. It seems there is going to be no cushion for falling home prices as they get back in line with earnings.

Ultimately it’s really hard to say what’s exactly going to happen in the long run, other then eventually prices and incomes will get back in line… how, is anyones guess, because the global financial crisis largely being uncharted waters.

In the short term though, real estate prices only appear to have one way to go. Down.

Personal Finances

If not now, when?

I don’t want those that read this blog to think I’m against buying real estate… I’m all for it, I just don’t think it’s a good idea to buy now.

If I had not been looking to buy last summer, I would have never dived into the numbers and ultimately started this blog. Up until then I pretty much accepted the idioms that real estate only goes up, and after seeing prices go so high, watching them come back down suddenly made them seem affordable.

Then you roll back the time frame a few years and, holy shit, you realize we’re ridiculously out of line with historical means… and then you start thinking there must be something more to the story… and for those who have been reading this blog for any length of time, you will have noticed I’ve been trying to tell it.

So, for those of you who were like me, my advice is this… wait.

Don’t try to time the bottom. It can’t be done without exposing yourself to extra risk and requiring a great deal of luck. The bottom will not be apparent until six months to a year later, maybe even more depending on how volatile the economy remains.

As they say in the investment world, don’t try to catch a falling knife. These prices are falling for a reason, there is not going to be another big run up immediately after bottoming out. The potential downside of prices continuing to drop is far greater then the small upside that would be realized from hitting the bottom perfectly.

This is just my take, but as a first-time buyer I’d rather pay a little bit more and know I’m buying an appreciating asset, then risk prices dropping another 50K, losing my down-payment and being trapped in the purgatory of negative equity for a decade.

Those that bought in 2007 are already there, I have several friends that took the plunge and they’re definitely taking a bath. It’s not a situation you want to find yourself in.

Speaking to those other potential first-time buyers out there, it is all about price and buying into an appreciating market.

The price you enter the market at will be felt throughout the rest of your life. No matter how successful those that entered during the bubble will be in future endeavours, their finances will never be as good as they could have been. That’s why bubbles are so dangerous, as much wealth as they may create, people tend to over-do it during the up-tick, and by time things have came back down to Earth more wealth is destroyed then was ever created.

The reason price at entry is so important is that all your future moves on the property ladder will be relative, you’ll be trading up based on the equity built up over time. That’s why being in negative equity is such a sticky situation, cause when you owe the bank more then what your house would sell for, even if prices of bigger places come down to a point you’d qualify to buy them, you’re not going anywhere.

You’ll probably buy bigger homes, probably carry bigger mortgages, but you’ll never made a more important decision then when to enter the market. And generally it’s pretty safe, for 20 years before 2005 it was probably fairly safe to buy-in at any time in there… but then we entered the bubble, and as people have been finding out, it’s now a very dangerous game.

Beyond that, most first-timers are not buying places they intend to stay in for every long. Often it smaller condo’s and town-homes and as they progress through life those are not enough to accommodate significant others and kids. These developments are coming hard and fast at those in their late 20′s – early 30′s, so often they only hold that initial property for only 2-5 years before trading up.

If you’re taking a 25 year mortgage on the place, you’re not making up much equity. After three years you’ll be lucky to have made up enough to cover your agent commissions and closing costs. After five years, you’ll have maybe that +5% (and god forbid you have one of those 30- or 35-year mortgages). So you need to make sure your home is appreciating.

To give you an example of how bad things can go, lets look at someone who bought an average-ish condo two years ago and is looking to sell. In spring of ’07 the “average” condo was going for ~$265,000, and lets say that person was smart enough to have 5% down and a 25 year amortization at 6% (the going rate at the time). So lets say they put ~$15,000 down, and finance the rest.

After two years they’ve made up $10,000 (actually closer to $9,200, but I like round numbers)… so they have $25,000 in equity, right?!

No. Problem is now the market rate for that condo is $227,000… and they still owe the bank $240,000.

They’re underwater for over ten grand, and we haven’t even factored in moving costs, realtor commissions and closing costs which is probably another 15 grand… and this was a person smart enough to have a down payment and not take a longer term.

If that person took a 0/40, that person would still owes that bank over $260,000, assuming they didn’t take the interest-only plan, which they might as well have for all they would have saved.

This is why I’m of the opinion that it’s really irrelevant how much someone thinks their house is worth, or how much equity they think they have in it. The only number that matters is how much you owe on it… everything else is trivial.

I’m also of the opinion that if you can’t pay it off in 20 years you probably can’t afford it… and if you can’t pay it off in 25, you definitely can’t afford it.

Anyway, end of rant.

Of course for the majority out there, they already have bought, and for those of you looking to trade up or down, it’s probably not a terrible time to buy actually, selection will never be better… just make sure you have the sold your old place before you even think of committing to another.

Like I mentioned before, for these people the property ladder is all relative… so if they overpay for their new place it really isn’t as big a deal since odds are someone overpaid for their place proportionately.

Though, if you’re looking to upgrade in a big way I might suggest holding off on that… cause if you’re living in a place worth $300,000, and looking at something worth $800,000, waiting until we’re closer to the bottom would be well worth it. All percent declines are not equal when it comes to nominal dollars, if the market goes down 10% sure your selling price would drop 30K, but your buying price would drop 80K… 50K is a pretty nice return for sitting on your wallet… and assuming we return to the mean, our drop will be a lot more then 10%.

And don’t get scared by the prospect of interest rates rising… because interest rates going up, forces prices down. What should scare you is the prospect of buying in at inflated prices and todays ultra-low interest rates… cause in five years you’d have little equity and the mortgage will be coming up for renewal, and if rates are high then, at that point you’re screwed.

So, long story slightly longer… here is what I’d look for to indicate the market is coming back into balance.

  • Prices have stabilized for six months or more
  • Absorption Rate consistently below 4
  • Active Inventory consistently in the 3,500-4,500 range
  • Sales consistently in the 1000-1500 per month range during non-spring month

If I had to guess a price range, I’d say look for detached home median prices to be $250,000 or less, and the residential average $210,000 or less. Now, this is highly speculative, but if I saw prices go appreciably below those, I wouldn’t be surprised if we overshot the landing and might see a small bounce back to the long-term mean… but I kind of think we’ll just sort of level off around there and prices will remain fairly stagnant for quite a while afterwords.

As I said before, my advice is wait.

We’re a long way from any of that happening in my estimation, so I advise taking some time now to learn about the market.

There is tons of inventory, so you’ll never get a better chance to see just what’s out there. Look around, you don’t need to buy. Go to open houses, or take a weekday afternoon off and tour a bunch of places. Learn what you like and dislike, and decide what you really want so that when it comes time to buy you’re going to make the right decision.

Personal Finances

Are agents feeling the pinch?

So tomorrow is Friday the 13th… and if that doesn’t scare you, just wait until the Feds announce the latest employment numbers tomorrow. Very ouch, I’m sure.

Today I’m going to take a quick look at an angle of the real estate industry that doesn’t often get much attention from we outsiders… the agents and their commissions.

Oh sure, many may curse them out for whatever reason, some think the commissions are too high, or don’t like that the buyer is represented by someone with a vested interest in a higher price, or find it odd that they trademarked their job title and insist it be capitalized.

I don’t know, I always just kind of figured it is what it is, but the capitalization thing seems kind of pretentious… but I guess you have to have some way of distinguishing REALTORS® from, say, Sandwich Artists®.

Whatever, I’m not going to get into all that. What I’m going to look at is how the bubble has effected their industry from an overall personnel and revenue perspective.

One interesting little nugget in the monthly sales pitch press release that most probably overlook is their little blurb at the bottom. This month it reads:

The REALTORS® Association of Edmonton (Edmonton Real Estate Board), founded in 1927, is a professional association of 3,148 Brokers and Associates in the greater Edmonton area. The Association administers the Multiple Listing Service®, provides professional education to its members and enforces a strict Code of Ethics and Standards of Business Practice. The Association also advertises property listings and publishes consumer information on the Internet at (formerly, as well as in the Real Estate Weekly and on their web site at The Association supports charities involving shelter and the homeless through the REALTORS® Community Foundation (RCF).

While at first glance it looks like just another disclaimer, or some small print… it actually includes a kind of interesting little factoid, that there are 3,148 agents in the city. They’ve been including that for several years now, and while it occasionally is a rounded figure, or blatantly copy and pasted from a prior years draft without bothering to update the tally, it gives a ballpark figure and when compiled actually reveals some interesting stuff.

Here we see that their ranks swelled in recent years. No surprise there. Between ’01 and ’08 their numbers grew by over 1,200 bodies, or about 59%. Also no surprise that with the market cooling we’ve seen a few leave recently, 133 to date according to their figures.

It is interesting to note that their membership was growing quite steadily even before the bubble really got going, and while it certainly picked up come ’06 and ’07, there actually wasn’t an explosion of new recruits.

From this data we can derive all sorts of (perhaps) interesting little figures when comparing it with their other stats.

Here we see the number of sales in a month, and the estimated commission per agent in that month. As we can clearly see, the seasonality in the sales is even further amplified in the estimated commission stat. According to these figures they earn 2-3x as much in any given May, then they do that December… 2007 in particular the difference was 3.6.

So if you think sellers are getting horny for Spring to arrive, you haven’t seen the inside of a real estate brokerage… and if you have, you probably needed a stick to get them off your leg.

And for those curious, no I didn’t just simply just calculate the commission by using the 7%/3% formula on that months average price, as sales <$100,000 would skew such numbers. I actually ran the numbers through about a dozen different calculations to account for sales by price range, et al in an effort to account for all the different variables. So while this number is not exact, I think it is a very good estimate. After all, ultimately there is no way of knowing the exact number without knowing the specifics of every transaction since there are instances of reduced commissions, etc. While that graph gives an excellent example of seasonality, and shows an overall trend reminiscent of the bubble, it doesn’t really offer a relatable finding for those of us outside the industry. So for that, we’ll use this chart.

This is a moving average of the estimated accumulated commissions an agent would earn over one year. As you can see, this one definitely does reflect the housing bubble.

Bear in mind, this is not before tax income. They have to pay all their expenses out of that… vehicle, gas, cell phone, incidentals, and then there is the multitude of memberships fees and licences they have to pay to their brokerage and organizations like the EREBAREA, and CREA.

This is also just an “average” and there is a whole lot of range of income in that profession. The Terry Paranych‘s of the world are still going to be making obscene amounts of money, though perhaps not as obscene as in 2007… while many that just went into that line of work in the last couple years or are part-timers, and haven’t really established themselves, are really going to be seeing a difference and feeling the downturn.

Those newcomers will also quite likely be the first ones to leave and find other lines of work. Which will provide something of a necessary purging of excess agents.

Those in the middle, which make up the majority, should be able to weather the storm. Though their support staffs will likely get cut back from their peak levels, this is also necessary since the work level just isn’t there to justify them.

As far as things have fallen in the last two years, the commission per agent figure is still at almost $70,000. A very healthy level when looked at from a long term perspective. So while things certainly aren’t as good as they were in 2007, they still appear pretty good on the whole.

So for those established agents out there I wouldn’t think they’re feeling the pinch just yet.

That could of course change. If over the remainder of 2009 sales remain about 20% lower then 2008 and the number of agents stays the same, even if prices don’t go down any further… by December that commission per agent figure will drop to ~$55,000, which would be lower then it had been anytime in the least eight years.

So if this sales slump continues through ’09, we’ll start seeing agents getting very antsy… and if it continues into, if not through, 2010, I imagine we’ll see a fairly significant thinning of the ranks. But for now, I think it’s mainly just the part-timers and the johnny-come-lately’s that are feeling the pinch.


Mortgages Personal Finances

Mortgages – The myth of acceleration

This is the first in something of an intermittent series I’m going to do on mortgages. Despite often being a persons single biggest monthly expense, all too often people really do not understand how they work. And since I also get all geeked up doing this sort of stuff… behold.

I sometimes hear people talking about how much faster and cheaper they’re paying off their mortgage by going to accelerated weekly or bi-weekly payments… this isn’t really true. What they’re really doing is just increasing how much they pay in a month.

They basically work by taking what a person typically pays in a month, lets say $2000 (to use a nice round number), and if one wants to pay bi-weekly, they’d just start paying $1000 every two weeks ($2000/2) or $500 every week ($2000/4).

Then, instead of paying $24,000 a year ($2000 x 12), they are paying $26,000 ($1000 x 26 or $500 x 52). So yes, it would be paid off sooner, and they would save a little on interest…. but the same thing can be accomplished just by upping one’s payments to $2167 per month though, which is effectively what they’d be paying anyway.

You’re not really gaining anything by changing the number of payments. To take a look at just how little one saves on interest, lets use $200,000 over 25 years, at 6% example. That could be paid off for $1288.60 per month, or $297.12 per week.

Over the course of one year a person would save a grand total of…. $12.79.

Slightly over a dollar a month. Which, if you’re on a automatic withdrawal, by all means, go weekly, it’ll earn you a free lunch once a year.

But if you’re doing the old school method of mailing in or dropping off a cheque at the bank, it’s really not worth your time…. between postage, time and/or gas you will probably end up going out of pocket.

Another thing to consider is your monthly budgeting. If you’re not carrying a decent balance and depending on your work pay schedule on the months you have to make an extra payment could obviously lead to some headaches.

So, in conclusion, there is little to be gained by going to weekly or bi-weekly payments that can’t be accomplished by merely increasing your monthly payment… which, if you can afford it, is a good idea regardless of your circumstances.