March 22, 2009
BuzzBuzzHome (Source: Greater Fool)

The Canadian press called Garth Turner’s 2008 book ‘Greater Fool’ both “prescient” and “scarily bang-on.” The former MP and best selling author is now predicting a made-in-Canada real estate disaster with the “potential to be every bit as nasty as the sub-prime teaser loans that felled America.”


His argument is as follows…

“The perfect storm for a mortgage crisis is brewing in Canada. Here’s why.

Unlike in the US, where resetting mortgages are an oddity, in Canada they’re routine. In the States, most homeowners have a 30-year home loan with a fixed rate for the entire time. In Canada, we play interest rate roulette. The normal fixed-rate mortgage term here is five years, and increasingly borrowers have opted for shorter periods of time, gambling that interest rates will be lower when the loan comes due.

But, no more.

The Bank of Canada rate is now at the lowest point in history – one half of one per cent. Bank prime rates are sitting at just 2.5%, and mortgages are being loaned out at a paltry 3%. It might be possible for rates to decline by another quarter point over the next few months, but already we’ve created the same situation here that existed for Americans taking sub-prime loans.

Rates can only move in one direction. Up. Over the course of the next five years, possibly way up. In fact, I’d say it’s a certainty.

Central banks around the world have been printing a flood of money to try and stall deflation and revive economic growth Public debt has exploded, governments have plunged headlong into deficit spending, countries are buying back their own bonds with tax money and banks have been nationalized while the money supply increases. In this are sown the seeds of inflation, once economic expansion continues.

And what will these central banks do to dampen down inflation before it creates its own monster? You got it. Raise interest rates.

So, if 3% mortgages in 2009 become 11% mortgages in 2014 (that is the historic norm over the last few decades), just imagine the consequences for someone buying a house today. After all, a $400,000 mortgage at 3% costs less than $1,900 a month to carry and requires an income of $69,000. But the same loan at 11% has double the payments – $3,850 a month – and takes an income of $139,000 to carry.

So anyone buying a piece of property with a mortgage today had better plan on doubling their income over the next five years to avoid a mortgage bombshell at renewal time. Or hope the value of your property explodes higher, building new equity and allowing you to tap into it to keep your finances afloat.

The odds of either of those things happening, I’d say, are nil.

Fair warning. Interest rates have hit bottom. House prices have sunk. Affordability has surged. Far from having scored right now, new buyers and mortgage-takers have embarked on a gamble they likely cannot win.”

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