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Imagine the Canadians who bought in the last 6 months. They probably purchased thinking it was a great investment and if they didn't buy now they'd never be able to afford a home in Vancouver.

And the shocking thing is just how big the losses can be when homes cost >$1M. If you buy a $200K home and the market drops 10%, it's a $20K loss of your down payment. A lot of money, but something manageable for most people.

If you bought a $1.5M home and the price dropped 10%, that's a $150K hit to your pocket book. And 10% is a small drop in an overheated market like Vancouver. It wouldn't surprise me to see a drop closer to 20-30%. That's a $300K to $450K loss for those home owners.

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Granted, short-term losses are undeniable.

But long-term, ordinary Canadians living in these properties stand to make out alright (indeed - assuming this is not a long-term depression in prices). They get their utility out of the property (if city rents are 2-3K/mo for a 2 bedroom, that's 480K over 20 years in "cost of renting the space" which they don't end up incurring).

I cannot speak for Vancouver, but scenarios in the US where cities saw non-trivial % declines had those % returned in-kind within a decade. So we're seeing short-term losses, it will impact folks selling today or tomorrow, but not in 10 years (as I've caveat-ed along the way: probably).

That is true, but unfortunately not everyone can decide when they move. Losing a job, having a family member get sick, etc can force a sale and realization of loses.

But overall, housing prices do increase over time relatively inline with inflation. So even if Vancouver takes a huge hit in the short-term, over the long haul it will keep going up.

One interesting thing I noticed is that some housing markets don't really go down that much, they just stop growing. I can remember the home my parents owned in Toronto. They sold it for $325K in 1990. In 2005 I looked up the price and it was about the same. Adjusted for inflation, the it was a price decrease.

> One interesting thing I noticed is that some housing markets don't really go down that much, they just stop growing. I can remember the home my parents owned in Toronto. They sold it for $325K in 1990. In 2005 I looked up the price and it was about the same. Adjusted for inflation, the it was a price decrease.

This isn't actually what happened in Toronto, to be clear. There was a huge housing boom (especially condos) in Toronto in the late 80s, followed by a bust. >100% gain in real housing prices between 1985-1989, then a 40% drop between 1989-1996. What you saw was a housing collapse which took until the 2000s to recover, not a flatlining.

Along the course of those 20 years will be 20 years' worth of property tax, home insurance, and maintenance that renters will largely not incur on top of rent (it is arguably built into the rent, of course).

The owner is not "saving" $480K, but a sum quite a bit smaller than that, likely around 20-40%.

They get utility, but they still have to pay the mortgage based on the old price. They'd get the utility anyway, without the price drop, so utility-wise the situation is neutral. But money-wise, it is a huge loss, which can make it very hard also to move - if you paid 20% down and the price dropped 20%, now if you sell the house, you only have enough money to pay the bank, and maybe a little equity you've accumulated on the way, which may be barely enough to pay closing costs, agent's fees, etc. But now you still need a house, and you need 20% down to pay again, but you no longer have any cash, or have very little of it, way not enough to pay 20% even of the new, lower price. You have only two choices here: give up the idea of owning a home for next 10 years or so, or hold out on selling until the prices go up again. I don't see a big win here.

That's ok because houses everywhere has dropped 20%. And if you still can't afford to move even if your dream home has taken a price hit at least you still have somewhere to stay.

The great part about a severe correction in home prices is that.. Well I think generally speaking... Luxury homes have a higher beta than non-luxury homes, i.e. Luxury homes correct harder than non luxury homes. If you're staying in a 1m home hoping to leg into a 2.5m home, it sometimes happen that a correction drops your home value by 150k and the target 2.5m home by 650k or more. So the hurdle to change home just got cheaper by half a mil... Which is a good thing!

The scenarios you mentioned are the risks of overleveraging and that applies to everything. Few people leverage their retirement portfolios. If your home value is 90% of your retirement, why take that risk? Would you gear 90% of your retirement portfolio 4-5x and put it in a single asset?

I don't think you calculations are entirely right. Let's consider home of price X. Most people would have to pay 20% down (you can get a loan for that too, but that would be overleveraging so let's ignore it). Let's say prices go down 10%. You lose 0.1X of your down payment, or half of it. Let's say you have to sell and move to another place, where you want to buy a similar house, now costing 0.9X. You need to put up 0.18X downpayment for this. However, after the sale you only have 0.1X (ignoring the sale costs, which can easily cost you another 0.05X-0.06X and making situation even worse). So you're now have to come up with 0.08X cash, and fast, otherwise you don't have a place to live in. Most people don't have this much free cash just laying around - it'd be in tens of thousands of dollars. If you are moving into more expensive home, the situation would be even worse.

The situation is actually even worse than this.

In Canada, they don't have fixed 30-year mortgages like in the US. They have 25-year mortgages with 5 year terms. They need to refinance within 5 years. If they take a 20-30% hit in the house costs, they will absolutely be unable to renew their mortgage, unless they come up with the cash to make up the difference in appraised value.

This will lead to a lot of forced selling or foreclosures which will only pull the house prices down further, and cause more forced selling.

What are 25-year mortgages with 5 year terms?

Do you mean the interest rate is fixed for only five years? If so, people will not need to refinance as long as interest rates stay low.

the interest rate is fixed for 3-5 years usually, yes

even if interest rates are flat (or go down, even) you can still be forced into foreclosure if your equity in the home drops below an acceptable threshold

It means the mortgage is based on a 25 year repayment schedule, but the money is only lent for 5 years at a time. After the 5 years are up, you need to pay back all the remaining principle. That's usually done by taking out a new 5 year mortgage.

Wow, that's utterly terrifying.

It's how it's been done in Canada for the last century. Normally interest rates don't change that drastically and if they do go up it's due to inflation which is usually reflected in a salary increase.

What would be really terrifying would be another period of stagflation (no growth, high inflation). You could see your salary stay the same, but your mortgage payments increase by 20-40% when you refinance.

Can they deny an existing homeowner a mortgage? In the US, getting a mortgage is often a convoluted process that takes weeks of effort to put together and can fall apart at any time.

Yes, it is possible, but more often the homeowner switches lenders themselves, since they are now able to negotiate for a better rate from a competitor.

The truly terrifying thing is that the banks have been adding clauses to the mortgages that on renewal if the market value drops below the outstanding balance, the homeowner is required to pay the difference in order to renew.

This is scary because they will not have paid off much in the first 5 years, but the house price can certainly drop a lot in 5 years in a down market, and there would be very little hope for finding a new lender willing to offer a new mortgage for more than the market value of the house.

Getting a mortgage in Canada is (in my experience) a very weird process for an agreement over such a large sum, but typically can happen within a week.

Wow, that's basically a 5-year loan. I'm surprised that Canadian home buyers accept such risk. I wonder why the mortgage market in Australia and UK is so different to Canada.

I think it means amortized over 25 years, balance due and payable in 5, meaning you make payments like it was a 25 year mortgage, but after 5 have to pay it off (often, as GP points out, by refinancing.)

That is extremely bad deal if you have to essentially re-apply for the mortgage every 5 years. I then wonder why nobody offers much better fixed 30yr there? Regulations?

30 year fixed mortgages are offered almost exclusively in the USA. They would not exist here if not for the massive government subsidies in the form of backing & tax breaks.

what rates of those fixed mortgages do these subsidies provide on average?

To me, massive government subsidies is more like in France where you can have a 0% interest 25 year mortgage if your household income is low enough.

Or the special account which gives a 2.6% fixed interest after having saved some money in a special savings account.

Freddie & Fannie own ~45% of the mortgages in the US. Ginnie has another 15.

In addition VA loans & FHA loan security is applied to something like 45% of loans. I've seen estimates that suggest the US taxpayer backs or owns 60% of loans in the residential market.

Maybe we aren't talking about the same thing, but most mortgages in Australia are 30 year, variable rate with a honeymoon period but no reapplication required throughout the loan.

My understanding is that is pretty similar to the US, but it sounds different to Canada.

We don't have the same tax breaks as in the US though.

In the US, you can get a 30 year fixed mortgage. Basically you set your interest rate when you take our the loan and it's doesn't change for 30 years.

It's really quite amazing if you think about it.

I know a guy who refinanced a few years back at 2.89%. That's insane as it's barely above inflation. He's basically borrowing money for free.

If inflation goes up to 5-7% over the coming years, his rate will stay at 2.89%, drastically decreasing the cost to pay it back.

If your 30-year mortgage is at 5% and you refinance it at 25 years at 3%, who pays the loss the bank takes due to the new, lower interest rate?

The bank. If interest rates go up a few points in the coming years, and it would be hard for them not to, banks are going to be sitting on a ton of mortgages that are not profitable.

That said, most loan originators sell the mortgage off. Many of those go to quasi governmental corporations that most people believe the US tax payers will bail out if necessary.

Ok, so in effect it's these quasi governmental corporations that assume the risk of rates going up (which would make it very lucrative to refinance), and that's where the subsidy lies.

We have fixed-rate mortgages in Norway too, but the interest rate loss or gain is realized when you refinance. Meaning that if you refinance to a lower rate, you'll have to pay the loss taken by the bank, and if you refinance to a higher rate, the bank pays you the loss you take. If you pay off the loan faster than scheduled, the same rules apply. So the risk is taken entirely by the borrower.

The banks mitigate the loss from early payment by heavily front-loading the interest - i.e. first years huge part of what you're paying is interest, and very little goes to equity (at least in default fixed payment scheme, you can pre-pay the principal if you want, but on top of the default fixed payments). The longer is the life of the loan, the more goes to equity and the less to interest. So if you close off the mortgage early, you've already paid a lot of interest that bank would have gotten. Of course, not all of it, but the bank also gets the money back earlier, so I don't think they lose too much.

The bank doesn't "lose" in that they are fully paid up to the date of the refinance.

The bank loses in that they are upside down on the spread. They have a mortgage which is paying a low interest rate but they have to borrow at a high one.

The mortgage is essentially a 30 year option, in those terms it becomes obvious why 30 year fixed mortgages wouldn't exist in an unsubsidized market.

You have to take into account all time periods from the time the interest rate charges started (beginning of loan) through to the time when the bank's loan is terminated.

They may have (potentially) had a few month's worth of being underwater but they were able to borrow at a lower rate also.

Further, there are several %age points of spread between what banks pay to borrow and what the mortgage rate is, further cushioning them. See the CIDOR here: http://www.tradingeconomics.com/canada/interbank-rate ... now compare with the mortgage rates a bank will charge.

EDIT: CIDOR under 1% but ratehub.ca says the best 5-year fixed rate you can get is... 2.42% .

A "refinance" means someone (which may be your original bank or someone else) lends you the balance to pay off your old loan, and you pay the new loan.

There's not really a loss, since the terms of your old loan allowed the early repayment.

That's what low rates are designed to do: make the credit cycle work faster, right?

That's correct. The 30 year mortgage wouldn't exist if it's weren't for the gov't coming in and backing them.

Before the Great Depression, mortgages were completely private – homeowners would generally string refinances one after another, and mortgage terms were less than 5 years. It wasn’t until 1934 that the Federal Housing Administration stepped in with an insurance program on mortgages, an amortization plan, and terms of 15-20 years (much like today, many mortgages are insured based on standardized programs – say, 30 years, fixed interest, 80% loan to value).

[1]https://dqydj.com/history-30-year-mortgage-private-mortgage-...

Understood, and makes sense. But even variable rate mortgages in US do not require maintaining equity threshold, do they? Maybe also consequence of govt guarantee. Though I wonder what Canadian central bank would do if it finds itself in the same situation of mass mortgage defaults/underwater mortgages as happened in US - I suspect they would also opt for one or another form of bailout, thus implementing implied, if not explicit, guarantee.

Tax breaks of course is another thing that massively influences US mortgages. I probably would never take my current mortgage if not the interest tax break.

>> They probably purchased thinking it was a great investment

You would think by now people would have learnt their lesson and stopped thinking of housing as a 'great investment'.

>> You would think by now people would have learnt their lesson and stopped thinking of housing as a 'great investment'.

Especially at a price of $1.5 million!!

For most people your house is one of your largest investments .

Largest, sure, but not most effective. A house is for most people primarily a purchase they intend to use (live in), with the added benefit that over the long term is likely one of their few material possessions that will appreciate instead of depreciate.

Granted, even if the 1.5M house falls by 30% this year, over decades it is likely it will still come out ahead, adjusted for inflation, compared to say, a savings account. But chances are, on average, it won't beat an index fund.

It's an investment in the sense that you have to spend a lot of money/get a huge loan upfront.

But many people also see it as a way to make money. Unlike basically everything else we buy for living, people think that the only direction the value of their house can go is up.

If you look at it like your car (it costs money, but maybe you'll get some money back), then you can't be disappointed. In the worst case, it's no different from paying rent.

Plus, unlike penny stocks, you can live in the house.

The obvious protip here: don't buy a second house unless you can afford losing money on it.

Once you factor in mortgage interest payments, taxes, maintenance, inflation, real estate commissions, your time, and the time it sits vacant while you try to sell it, it's usually a lousy investment.

Much better off investing in the S&P 500.

You can't live in S&P 500 ;)

Also, when you factor this in - the landlord also knows how to factor those in. So rental prices won't be far behind. There are a lot of factors in renting vs. owning, but it's not clear-cut either side - you need to always look to specific local prices.

You can always tell if a market is insane if rent/sale ratio becomes too low.

There are many markets where renting makes perfect financial sense.

> You can't live in S&P 500

Getting a place to live is quite different from getting one as an investment.

> the landlord also knows how to factor those in

Rents are determined by supply & demand. They are not determined by whatever the landlord pleases to charge any more than whatever the renter pleases to pay.

> Getting a place to live is quite different from getting one as an investment.

Not really. You need a place to live anyway, so why not get one that can also would appreciate in value? Alternatively, getting one that would depreciate can be financially ruinous. So investment consideration is always there, even if they might not be always the primary one.

> Rents are determined by supply & demand.

That's a platitude. But you are thinking of "supply and demand" to narrowly - nobody would purchase a rental property that brings in less money than it takes out, whatever demand is around. There's a price floor for rental price, and that's how much it costs to the owner to get and maintain the property. Short-term, the price can drop below it since selling house takes time, and the market may be not good. Long-term, nobody would keep such asset. People don't do it for fun, they do it for money. If selling is more profitable, they'd do that.

Home price appreciation depends on location, so it's hard to generalize. Also unlike stock investments, a mortgage gives you massive leverage.

The massive leverage is precisely why I would never buy a house on a mortgage. With the 10x+ leverage most mortgages give you these days, it's absolutely terrifying how quickly you can accumulate losses of multiple times your principal. Definitely not what I'm looking for in a long term investment.

Not saying it's risk free, but smart real estate investments can crush stock market returns precisely due to that massive leverage

Yes absolutely. Everybody has a different appetite for risk. If you understand the risks involved and can tolerate the downside potential, a 10x+ leveraged mortgage has the potential to be one of the most lucrative investments opportunities available, due to the massive leverage it offers at dirt cheap interest rates.

What I'm fearful about is that the large majority of mortgage buyers don't see it as a 10x leveraged investment, nor do they understand how badly the amplified price fluctuations of a 10x leveraged investment could hit them if there was even a tiny dip in the price of their homes, let alone another housing crisis like 2007.

This. In Spain, where the housing bubble bust is still widely felt, economic and finance newspapers are starting to report (or pitch, I'm not really sure) that "Spaniards are starting to invest in housing again".

We don't learn.

I have no way of substantiating this, but it seems to me that there has been a shift in mindset, at least where I live, from the investment being that you slowly pay it off and eventually own your home, to speculation that the housing market will go up.

A coworker was particularly happy that his apartment had appreciated a lot in value since he bought it. Now, what he doesn't take into account is that the rest of the market has appreciated just as much. It isn't that his apartment has magically become more valuable, it's the entire market that has moved. The only way to realise that profit (without renting) would be to move somewhere where apartments are less expensive for the same standard, which he is not going to do.

I think the reasons people like property are:

- They think they understand it. Everyone lives in a property, right? And they have an opinion about which parts of their town are nice.

- Access to leverage. There's not a lot of things you can buy where the bank gives you 60-95% of the money you need, depending on the country and your situation. Other places where you can get this kind of leverage tend to have a bad rep, such as spread betting.

I'm completely unfamiliar with the Canadian real estate market, but where I live your ability to get a loan depends on your income and ability to pay the loan.

Given that, why does it matter if someone in Canada had a $200K home and the market dropped 30%, v.s. someone who had a $2M home and the market dropped 30%? Surely their earnings were priced into the loan?

Or is the Canadian real estate/loan market so insane that nobody asks you if you can plausibly pay for the loan you're taking?

Generally, you are correct. However, you need to take into account someone's down payment.

If you're making $300K per year and you buy a $1M house, then yes, a loss of $100K-$200K is probably manageable. However, a lot of people don't make that much money. What they did is scrap together a down payment, sometimes borrowing from Mom or Dad. They get a mortgage payment they can just afford on a salary of $100K.

The other thing that happens is that some people will get a 2nd loan to cover the down payment requirement. There are regulations against it, but it does happen.

You are going to be hard pressed in the US to get a loan for more than 4x annual salary with 20% down. Unless you are borrowing 500k for a down on a 1 million dollar house.

Guidelines for confirming mortgages allow a 38% household DTI ratio. So a $1M home with $800000 loan comes out to around $5000 (3.875% ARM), putting minimum income at $160k. So 5x salary with 20% down.

The government-backed mortgages are capped below $1M though, aren't they? I thought jumbo loans were portfolio loans, so government criteria didn't apply.

AFAIK the problem often is that the home is collateral for the loan, and when prices fall the bank demands more collateral to match the loan (even if you could still pay your monthly payments). If you can't pony up, the bank may take over and sell with the current (lower) price. You're left with no home and still have to pay the part of the loan that remains due to price difference.

Disclaimer: not sure this is how US/Canadian mortgages actually work, but this screwed lots of people in a certain financial crisis I know of.

I can confirm that Canadians banks do this, but I'm not sure if it happens all the time.

One of the biggest differences between Canada and the US is 30 year terms for mortgages. They are standard in the US and allow you to lock in a fixed rate for pretty much the rest of your life.

In Canada, they still do 30 year amortization, but loans are typically 5 year. You can get 1 year sub-prime loans with very low rates or 10 year fixed with higher rates. The 5 year is the most common.

What this means is that you don't get to enjoy a fixed rate over your lifetime. Get a mortgage for 4%? Great, it might be 7% 5 years from now. In other words your monthly payment could increase substantially.

Since you need to reapply for a mortgage in Canada, the banks will reassess the value and make sure you have enough collateral. I have heard of people refinancing after a downturn and the bank asks for another $5K to $20K to make sure you have the minimum 20% equity.

This is exactly the same problem as the UK housing market.

Mortgage loans typically have 2-10 year periods of discount or fixed rate (with the lowest interest rates normally found on the 2 year plans), then they revert back to the 'standard variable rate' which is significantly more expensive, and subject to change at very short notice. To keep a low interest rate you have to reapply for your mortgage every few years to get a new deal, and with reapplication comes the requirement to have a certain percentage of equity to loan.

Lending is pretty lax, just like it's been in spots all over the planet for over a decade.

One of the problems is that Canadian banks will make loans to foreigners with no credit history if there's a decent down payment. The banks typically demain that Canadian borrowers get a federally insured mortgage, which involves checking your income and credit history.

So it's actually easier for foreigners to speculate on real estate in Canada.

One of the problems is that if a foreign owner ends up underwater after a correction they can easily just walk away.

Six months ago people knew this was coming. If they bought at that time they were just ignoring the writing on the wall because they wanted to play real estate casino. No sympathy for sad house flippers, sorry!

They can live in it. How is this an investment? They are adding no value so should get a cut of that: nothing.

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