Blessed by the Potato

The government, in a bit of a surprise move today moved to tighten mortgage lending rules to help reign in the housing bubble here (which, for political reasons they can’t actually admit exists). I don’t mean that rules of this sort coming into play were a complete surprise, indeed there has been much speculation and hope that some sort of tightening would be employed in the budget. Just that it was a surprise to come today when the federal budget is less than a month away. To me that’s an actions-speak-louder-than words type thing, that these rules couldn’t wait until the spring frenzy.

Anyhow, on to the new rules:

The weakest in my opinion is the new rule that refinancing can only take one down to 90% equity. It’s to help prevent people using their homes’ rising valuations as ATMs, but I have trouble seeing how it might actually prevent a bubble — just maybe lessen the pop since it makes it a little harder for existing homeowners to put themselves underwater alongside new homebuyers.

The way the banks and the CMHC will calculate your debt service ratios (i.e.: how much house you can afford) will change slightly, so that now you must be able to afford payments at the 5-year fixed rate instead of the 3-year one. Since the 5-year rate is currently a few hundred basis points higher than the variable-rate, it will help protect people from themselves, and ensure that a small jump in rates won’t cause people to have to leave their homes. Supposedly, many people in this rate environment are taking 5-year mortgages anyway, but I have to suspect that this is going to screen out at least a few first-time buyers whose real estate agents have sold them on a price point based on the “monthly carry” at 3% or some ridiculous temporary interest rate. Personally, I’d like to see this as an even more conservative rule: i.e., ensuring people could afford their houses if rates shot up to beyond the current 5-year rate — perhaps an arbitrary 8 or 10% rate, or perhaps the high water mark for the last decade (though that can also lead us towards fooling ourselves in long periods of declining rates).

The last point is the one that I think is the most needed, and will do the most to stem speculation: people buying real estate other than as their primary residence, i.e., speculators, must put down at least 20%. So anyone that’s been investing in multiple condos in Toronto because you only need 5% to get your foot in the door will find that they have to have some money to buy. Unfortunately, it’s probably also the hardest to enforce — after all, if you search the blogs of the speculators, you’ll find they seem to skate around the other principal residence rules in efforts to make their flipping gains tax-free. I’m sure they’ll argue that they intend to live in each of their units, but had to buy the next three before selling the first… Depending on how this rule is implemented, it could start deflating the condo market quite quickly: if people who signed up for a dozen pre-construction units two years ago for completion this summer find they now have to have 20% down at the close, they may be in a terrible rush to sell. If existing contracts aren’t affected though, then it will still take some time for the hot air to work its way out of the system — which is probably how this will be implemented.

So, some quick (slightly inaccurate) numbers:

Let’s say you’re a couple with a gross income of $100k. 32% of that monthly is $2666/mo — that’s the guideline maximum for your mortgage payment, heating costs, and property tax. Let’s assume your heat and property tax are a fixed $300/mo, which leaves $2366/mo for the mortgage. With a 35-year amortization and a 3-year posted rate of 4%, you can afford a morgage of about $534k. At the 5-year posted rate of 5.4%, that maximum possible mortgage drops to $446k. A decline of ~17% in the maximum house you can buy. Depending on how many people were actually at the limits of their debt service ratios, that could undo the massive run-up that we had in 2009 as a result of the low interest rates.

Here I am on a holiday Monday, looking at the inside of people’s brains — basically technological mind-reading — while making funny noises with my mouth.

Boom-bi-chika-bum-ba-bum-ditty-do.

An RRSP is a tax-sheltering account. Any money you put in it is considered to be “pre-tax”, or tax-deferred, so you are not taxed on contributions you make. If, like most working Canadians, you pay taxes in advance as a deduction on each of your paycheques, this means that you can expect a refund of the taxes you paid on the money you stick in your RRSP.

You can contribute money to your RRSP any time through the year, and also all the way through to the end of February of the following year. However, people being the way they are, tend to leave it until the last minute creating “RRSP season” in February. It was into the midst of this chaotic selling frenzy at the bank that Wayfare made an appointment at the local TD to review her RRSP account (in fact, she was called in to update her risk profile survey). It was there that she was shocked by how misinformed the saleslady at the bank was (and believe me, they are salescritters and not “advisors” or “planners”).

After educating herself (with no small amount of help from yours truly, if I may pat my own back) Wayfare has realized that a lot of the products sold at the bank branch are expensive, with high fees (aka MERs) designed to make the bank rich, rather than her. So she (with some small amount of administrative confusion) converted her RRSP account to an e-series low-cost index fund account almost 2 years ago. At the branch, the salescritter saw that she was in these broad market index funds (~80% equities, ~20% fixed income), and said that her investments were too conservative for her age. Then she tried to sell her on a “balanced fund” which was “more appropriately aggressive”, with nearly 40% in bonds. For anyone who’s even remotely knowledgable about matters financial, you’ll immediately recognize that this is a far less aggressive fund (not to mention more expensive!). Wayfare actually had to hold the line to not get switched over to this poorer option — the sales push was fairly hard. And to add insult to injury, the salesperson spent the whole time selling, and never actually updated Wayfare’s risk profile, her original reason for going in! “We could do that next time when you make an appointment with me to switch over to these funds.” Give me a break!

A few years ago, being just a little less knowledgeable, she probably would have acceded to the salescritter’s suggestions (indeed, 3 years ago she walked out invested in a “market-linked GIC”, which while generally bad deals, was not such a bad idea in hindsight with the market crash of ’08).

So, to the rest of you: remember as you rush out to fill up that RRSP contribution room at the last minute with little time to check your facts that the salesperson at the bank branch is not necessarily your friend, and may in fact know less about the products they’re pushing than you do (or, at least than I do ;). If you’re young (as I believe most of my readers are), and if your RRSP is holding GICs (or equivalently, savings accounts or money market funds), then you’re probably doing it wrong (or have exceptionally low risk tolerance). You can hold stocks, bonds, cash, or mutual funds which own combinations of those. If you have a time frame of decades then you should probably have at least some exposure to equities (though the exact amount will depend on your risk tolerance). And fees matter.

I’ve been using the same towel for two weeks now, and it doesn’t smell like death. Living mould-free is the way to go, I tell you.

I’ve been amazed at how quickly my desk re-cluttered. Not 3 weeks ago everything was packed up into boxes for the move, or thrown out as junk. For the first week or two I kept my desk as clean as possible so that there was plenty of open space to do double duty as my eating table (since the kitchen table was piled high with boxes of kitchen stuff to be properly put away after the move). Now after just a few days of working on my lecture for this morning, it’s every bit as bad as it was before the move, if not worse. Pop cans, candy wrappers, and papers piled everywhere.

Finally, a teaser: John Hempton at Bronte Capital had an interesting post about the demographic crunch coming our way in a few decades, and what that might mean for socialized medicine. Once I catch up on my sleep I plan on doing a short post on the matter.

As I alluded to a few days ago, the accelerator pedal brou-ha-ha at Toyota may open the door for a good deal on a Prius (or, it may not, since it’s one of the few cars they can still sell). I’m going to email a few dealers for quotes tonight, so we’ll see what they say.

The Prius is a very strange and polarizing car: a lot of people have a very visceral and inexplicable dislike of the car. I’ve been surprised at the number of people who’ve said bad things about it at the merest mention that I may, at some point in the future, buy one. Pretty much all of them are myths (many of which have been debunked right here), or incomplete ideas about cost and payback (or apples-to-oranges comparisons). There are of course some valid criticisms, such as that the acceleration is not sports-car-like (it’s fast enough for a highway merge, which is all that matters to me), or that there are cheaper options if I’m focused purely on the financial aspect (I’m not — it’s one I talk about a lot, but the car has a lot of other merits). In particular, a used car would be cheaper (the hybrids keep their value too well, so it doesn’t make sense to me to get a used Prius). One of the best criticisms came from my friend Ryan who said “The thing about the Prius is this: it’s fuel efficient. It doesn’t use gas. And I make gas, so that’s bad.” [He’s a petrochemical engineer]

Nonetheless, people seem to want to criticize this car choice. I’ve made every attempt to look at it from all angles. I’ve updated my payback/savings spreadsheet with current gas prices and used a Matrix XR with automatic as my comparison car. You can download the 2010 version here if you like (or go to the Them’s Fighting Words post, which explains many of the factors that come into this kind of decision. Since gas prices have come down I’ve become more conservative with my gas price assumption, but even if gas prices stay at 95 cents/L for the next decade, the Prius will still save me several thousand dollars over a Matrix (even though the Prius is more than $5k more expensive up front!). That should handily pay for a battery replacement in the unlikely event one becomes necessary.

So we’ll see what the Toyota dealer says, but assuming they offer me a good deal, this may be your last chance to talk me out of it!