Your Money Book

Yesterday, the Finance Minister announced a number of new regulations designed to tighten the lending standards for mortgages insured through CMHC. The main three are:

-Refinancing is now capped to 90% of appraised value, down from 95%
-Mortgages on investment properties now require a minimum of 20% down payment
-First time home buyers must have enough documented income to qualify for the payment equivalent of a five year fixed rate mortgage. The buyer may choose a variable rate option at a lower payment, but the income has to be there to be able to make higher payments in anticipation of rate increases.

In practical terms, on a $200,000 mortgage, the buyer needs to qualify for a $1065 payment of a five year term, even if they choose a variable rate mortgage that would actually be $923 a month. (Currently at 4.09% vs. 2.75%). That translates to an additional $345 a month of income, or reducing other monthly payments by $138 a month.

That brings me to my trip to Vegas last week. Vegas is one of the ground zero cities in the U.S. mortgage meltdown. The city that never sleeps had a decade of building house after house, and selling it to investors with no money down, gambling they’d be able to flip it at a higher price to the next buyer – kind of a legal pyramid scheme. And homeowners saw the value of their homes double and triple over a decade and, on average, cashed out their equity every two and a half years, for an average of $30,000 each time.

Now that the music has stopped and reality has set in, the majority of residents owe way more on their homes than the value. You won’t see the devastation on the strip, but drive a few miles north on I-95, and you see foreclosures and bank owned sales, after foreclosure and empty homes.

An even bigger problem are the upscale, luxury condominium projects that just came on line in the last year. They’re 20-30 stories, often, like the Panorama complex, multiple towers – and pretty much empty. At the end of the strip is a twin tower called One – Las Vegas. I saw four cars and a security guard. I’m guessing one entire tower of 20 some stories is empty.

Visitors to Vegas are down 10%, and I’m surprised it’s not way higher. The casinos, hotels, and malls are noticeably empty. Gambling revenue is also way down and the hotel occupancy rates are the lowest since 1984. The Tropicana is in bankruptcy, and even Hooters Casino is in default on their loans.

Unemployment is over 13%, and expected to peak at about 14.5%. Vegas has the greatest fall in personal incomes, highest national foreclosure rate, and the largest percentage of homeowners who owe more than their home is worth.

THAT is the end result of a real estate bubble and insane speculation of buying homes people couldn’t afford, with teaser, variable rate mortgages and no down payments. It works for a while, but it’ll always come to an end. THAT is why the Finance Minister preemptively amended mortgage rules before we potentially get to that point.

Every kid puts their hand on a hot stove once. Yet us adults keep making stupid financial gambles over and over, somehow thinking the next time will be different. Yes, it’s our money, but when our gambling starts to affect the overall economy, it is reasonable for the government to set some basic ground rules.

My rules, and advice for anyone who will listen, go way beyond that:

-Broke people shouldn’t buy or own homes.
-Never buy an investment property without at least 50% down. Because when the roof needs to be fixed or there’s no tenant for two months – you’ll lose it all.
-First time home buyers need to be debt free and have 20% down to avoid our outrageously expensive mortgage insurance in the first place. It’ll make it a dream home, not a mortgage and debt nightmare.

This week, RBC released their Consumer Outlook survey, and it shows that more and more of us are worried about our debt load. I think that’s great news in that we’re finally getting real and seeing that borrowing money does not work, and being broke is not a fun way to go through life.

Fundamentally, it’s a real problem when we stay optimistic about our debts. THAT is what gets us broke! When we talk ourselves into buying this or that on credit, thinking that the payment isn’t that big a deal, we’re on a slippery slope of trouble. We block out the fact that it might take two minutes to spend it, but it’ll take years to pay it off!

A way better mindset is to be pessimistic about our debts and optimistic about our incomes. Instead, the survey shows that we believe we can become debt free reasonably quickly, but we’re worried about our job security. To me, that’s the wrong way around. We should be pessimistic about our finances. It’s what makes us realize maybe we can’t pay that payment for years, what happens when rates go up, I’m going to be in trouble if I carry my credit card at the max, and so on.

Yet, on the income side, 24% of us are worried about a job loss. To put it in perspective, however, the unemployment rate is 8.5%. But 5.5% or so is full employment. We know that from just a year or so ago. So, the real unemployment rate is around 3% and 24% of us worry. That’s a total disconnect between the two!

On the optimistic side, thinking we’ll pay off our debts pretty quickly, the numbers are even more surprising:

18-34 year olds expect to be debt free by age 43.
35-54 year olds think it’ll be at age 59. Yet, the group that’s closest to that age, those age 55 and older, think it’ll be at least until age 66! So a heads up to those under age 34: It ain’t going to happen! No way, no how – honestly. Sorry to be the bearer of bad news, but the reality is that you’ll likely have a mortgage payment of 25 to 30 years which right there, alone, makes it impossible.

And almost everyone under age 54 has a car payment. The average car payment is $480, financed over seven years. What’s a seven year old car worth? Exactly. So what happens then? We finance another one and go on another seven year broke cycle. Skipping one of these seven year finance cycles and putting that money into an investment account or RRSP will be over a million dollars when you retire. Instead, we buy something that’s worth less and less each month and keep paying and paying.

Keep in mind that every time you commit to a payment, you’re voluntarily taking a pay cut! That payment has to be made, so it’s money you no longer get to keep! It may be that $200 credit card payment, $400 car, the financed furniture, or whatever. Yet, if our boss wants to give us a pay cut we go insane. But we do it to ourselves every time we borrow!

One more thing which will become really important to all of our finances over the next year or so: The RBC survey showed that only 57% of us think interest rates will go higher. Excuse me? Rates are the lowest they’ve been in generations. So when they move, where do they HAVE to go? Up! And every line of credit and every variable mortgage will take some big jumps. The It’s Your Money book has a chart that asks how ready we are for the next rate increase. Anyone with just $150,000 of debt being hit with a 3% rate increase will spend another $329 after tax for nothing but more interest. And if we say we’re broke now, where’s that $329 going to come from?

What can we do? The really easy basics that 90% of us won’t do:
-Stop borrowing – period. When you’re in a hole, it makes sense to stop digging. Debt is NOT your friend.
-Do a written budget each month to know, not guess where your money is going
-Stop going to a restaurant unless you work there
-If your car is financed – sell it, no matter what you owe. That saved payment alone will likely get all your other debts paid off within a year. Drive a $2,000 beater for a couple of years until you’re debt free.
-Pay yourself first: Have some money taken right off your pay, or out of your bank account towards savings. If you don’t see it, you can’t spend it.
-Leave the credit cards with a relative. Out of sight, out of mind, and start paying in cash or by debit card.
-Get an emergency savings account of two weeks income so the next crisis will just be an inconvenience.