From the Financial Times – Lessons for the American housing market
Written by a senior lecturer at Harvard Business School and author of Too Big to Save? How to Fix the US Financial System, this article is interesting in the way that it lays out a series of lessons to the American public, while at the same time making a reasonable argument as to why our Canadian housing market has survived.
People like Garth Turner would love to have you believe that our credit practices are the similar to that of out American counterparts. He uses phrases such as “Canada’s version of sub prime” to scare the heck out of potential buyers and support his “the sky is falling” real estate predictions. The fact is that our credit practices are completely different, and Robert Pozen recognizes this. Garth, pay attention!
Take a look at the three reasons Pozen thinks our system is better.
First, Canadian banks routinely require home purchasers to make down-payments of at least 20 per cent of the purchase price of their home. Even in the government programmes to help low-income families buy their first homes, the minimum down-payment is still 5-10 per cent of a home’s price. With substantial personal net worth at risk, Canadian homeowners are very reluctant to default on their mortgages.
Second, in Canada, when a homeowner defaults on a mortgage, the homeowner is personally liable for any deficiency that remains after a foreclosure and sale of the home. Suppose a Canadian buys a luxury apartment for $800,000 with a $640,000 mortgage, and later defaults on that mortgage. If the bank forecloses on the mortgage and sells the apartment for only $600,000 the Canadian will be personally liable for $40,000 (the $640,000 mortgage minus the $600,000 sale price).
Third, Canada does not provide a tax deduction for interest paid by homeowners on their mortgages. By contrast, US law allows Americans to deduct the interest on the mortgages for their principal residence as well as for their vacation homes. Moreover, US law allows homeowners to deduct the interest on ”home equity” loans. These loans are typically second mortgages used to pull out some of a home’s equity built up over the years
Nice post Nolan.
There is no doubt in my mind that attaching a personal guarantee to mortgages will make people think twice about just walking away from their homes. There will be some angry people because they can’t afford to sell, but whatever. People will get over it.
I’m more interested in your thoughts on rising interest rates acting as a natural anchor on property values. That’s what I think will happen, stagnant values for a little while until incomes catch up to home values. Would you say the average house price in Canada will be up in 5 years? How much? (Not to put you on the spot or anything :D)
I admit, I read Garth Turner. The comments are particularly entertaining. He’s got some real whack job readers!
The good news is that there is already a personal guarantee in Canada. The bank has every right to chase you for losses – most people just are not aware of this.
As far as my thoughts on rising interest rates go, I am the first to admit that no ones crystal ball is even capable of being clear. I never make predictions, I try to prepare my clients for possibilities and let them make informed decisions.
What we know is that we are in an emergency interest rate scenario. Eventually emergency rates will end and will go back to normal. The question is what does normal look like? The answer, it looks like stable inflation. I do not think rates will go to 7, 8, or 9, percent as some are predicting. In fact, I think there is a possibility prime could hover around 4% for a very long time, keep in mind though that this is not a prediction, it is a possibility. It will all come down to inflation remaining stable.
Ultimately, I think there are too many other factors involved in predicting housing market fluctuations than to solely focus on interest rates. You have to look at what would happen to rents if it became to expensive to own (they would go up, making owning look better again, causing more demand on housing), as well as other factors such as migration, job markets, etc. There are a lot of unknowns to make any sort of reasonable prediction. What is important is that people who buy, buy with the intent of living in the same house for the long term. Long term ownership will always out benefit renting.
Cheers,
Nolan