Be Kind to your Banker: new release

After a few weeks of admitted laziness, last weekend I finally finished my second book. I hope you like it!

The official press release follows below...

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Be Kind to your Banker: new book explains lending from a banker’s perspective.

Be Kind to your Banker is the latest release from finance writer Eldon Frost, author of The Intelligent Investor’s Mind.

Be Kind to your Banker is written for three types of readers: those who have recently been declined for a loan or mortgage; those who wish to receive a better rate on a new or existing one; and, those who simply wish to improve their personal financial knowledge.

"When I worked as a lender," Frost explains, "it was striking to me how many people were unaware of how the loan process works. For example, people with good credit would apply for loans that they could not possibly afford, and would be surprised to be turned down. Even worse, they might be approved! This book explains step-by-step how the loan process works, and how a banker views an application."

"Everyone should know how to save money on a loan or mortgage," Frost adds, "and everyone has the right to know if they are making the best financial decision. These are the kinds of things that should be taught in school - but aren’t."

As the cover explains, the advice in this little book (just 80 pages) could save you hundreds or thousands of dollars.

Be Kind to your Banker is available at www.amazon.com in paperback format only.

- ends –

Throwing Away Money on Rent

“I want to buy my own place. I don’t want to ‘throw my money away’ on rent anymore.”

As a banker, I hear this sentiment often.

Amongst the reasons renters want to purchase their own place is because it annoys them to “give their money to a landlord” every month, allowing the landlord to get rich.

For most people, buying real estate is indeed a worthwhile and sensible economic decision, to say nothing of the pride of ownership and positive sense of responsibility that comes with owning a home. However, many renters have a twisted idea of how their finances will change once they purchase. To illustrate, I will use “Bob,” a typical renter.

In Bob’s marketplace, he pays $1000 per month for a 1-bedroom apartment with den, with hot water and cable TV included. He hates the idea of throwing away $1000 every month, so decides to purchase a condo in the same area.

Bob buys a $260,000 condo, using a down payment of $30,000 and a $230,000 mortgage. Bob’s monthly mortgage payment is $1234.69. He pays an additional $200 per month for condo maintenance fees and $100 for property taxes, for a total monthly payment of $1534.69. Bob is pleased with his decision. What Bob is not aware of is that he is actually “throwing away” more money now than he was prior to his purchase.

Bob’s first monthly payment will be $1534.69, of which $958.33 will be interest, $200 for maintenance fees and $100 for taxes, with only $276.36 going toward the principle. That is, Bob is now “throwing away” $1258.36 ($1534.69 – $276.36) - a full $258 more than before, not including the utilities and cable that he now has to pay for himself. Over time, more of Bob’s money will go toward the principle, but at the moment Bob is deeply in the red compared to his previous situation. Did Bob make a mistake?

In order to make a wise real estate investment decision, certain rules are best followed:

1) Don’t buy into a declining market (or an exceptionally “hot” market which could soon decline) unless you plan to stay in your home for several years. It is best to purchase when values during the previous 6 months have been roughly flat or rising. There is no point paying $276 toward the principle every month (like Bob), if the value of your property is dropping more than that.

2) Don’t purchase unless you intend to stay in a place for 3+ years, with 5 or more being optimal. During shorter periods of time market values can decline (see Rule 1), and fees (such as moving fees, agent commissions, taxes etc) will take a bite out of any potential profits.

3) Buy something well within your comfort zone. No more than 32% of your monthly pre-tax income should go toward mortgage payments and condo fees.

4) Make sure you have fallback funds. Too many people put all of their savings toward a purchase, leaving nothing for emergencies.

If Bob intends to stay in his property for 5 years or more, has funds set aside for emergencies, and has purchased in a flat or rising market, he has probably made a wise investment decision. Over the years, his monthly payments will remain the same while local rents rise, with more of his payment going toward the principle (and less toward interest) every month. And, he will see his property increase in value while he enjoys living there.

Real estate can be a great investment. Just make sure you do it right.
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“The only difference between a cult and a religion is the amount of real estate they own.”

Frank Zappa, musician

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Bob’s Mortgage

Principal = $230000
Interest Rate = 5%
Amortization Period = 30 Years
Bob’s monthly payment is $1234.69
First year mortgage amortization schedule (click to enlarge):

The Canadian Real Estate Market: Trouble in the Pipeline

The Canadian Housing market is going well, with big volume and qualified customers. At least, that’s the current perspective at the end of the line. The further one goes up the pipeline, however, the worse the big picture looks.

A mortgage department employee from a major bank recently told me that application volumes are down 25% or more since June 15th. Though employees are not being laid off, those who leave or retire are not being replaced. At the same time, the quality of mortgage applications is deteriorating rapidly (“scraping the bottom of the barrel” was the exact expression).

Further up the pipeline, Real Estate agents tell me they are worried. Sales have dropped noticeably since May. In an attempt to make up the difference, agents are cold-calling and self-marketing like they have not done for a very long time.

Of course, all this is anecdotal evidence. At the bank level, sales numbers still look great. Yet, I suspect that the drying mortgage pipeline will reach Canadian banks soon. When it does, you will read about it here.

For further information, see:

Spin City
Canadian Debt II
World Housing Bubble II
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"Phew. With yesterday's report that home resales are cooling and price increases shrinking, we can finally put behind us the horror of Canada's great imaginary housing bubble. ...What Canada had was modest overvaluation with very little sign of speculation."

Jay Bryan, The Montreal Gazette, June 17 2010.

The World Housing Bubble - Part II

Just in case you thought it was over...

Back in March, The Frost Report noted that during the economic crisis of 2006 and beyond, countries around the world drastically lowered interest rates to spur economic growth. Like the Frankenstein monster, the good intentions of these low interest rates have morphed into a hideous mess: a multinational, worldwide housing bubble.

Some economies have already moved from the "we don't have a bubble" stage to the "bubble is beginning to burst" stage, while others are still recovering from the first one. In case you missed the original article or it has faded from memory (see: World Housing Bubble), here is another selection of this year’s headlines to remind you that the problem is far from over.

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THE UK

House price rises ‘unsustainable’ as lending falls
The Times, June 2nd 2010

"Vicky Redwood, Capital Economics’ senior UK economist, said that the data 'continues to suggest that the recent rise in house prices is unsustainable'."

http://business.timesonline.co.uk/tol/business/industry_sectors/construction_and_property/article7142355


CHINA

May property sales plunge in Beijing, Shanghai, Shenzhen
Xinhua, June 2nd 2010

"Beijing, property signings slumped nearly 70 percent to 3,357 in May from April, the Shanghai Securities News reported, citing data from the city’s housing regulator. In Shanghai, transactions may have dropped about 70 percent to 2,550 signings, the paper reported, and in Shenzhen, sales fell 62 percent."

http://news.xinhuanet.com/english2010/business/2010-06/02/c_13328894.htm


AUSTRALIA

Interest rate rises subdue housing bubble
The Australian, June 1st 2010

"The Reserve Bank of Australia's rate rises have pricked the boom in housing prices and have also sent lending to businesses skidding into reverse."

http://www.theaustralian.com.au/business/property/interest-rate-rises-subdue-housing-bubble/story-e6frg9gx-1225873746105


KAZAKHSTAN

National Bank Chairman: Kazakhstan Focuses on Economic Recovery
Ministry of Foreign Affairs, May 4rth 2010

"Kazakhstan was one of the first countries to experience the global economic meltdown of credit. As a result, it was one of the first to respond with a comprehensive program to deal with problem sectors, such as banking, financial services and property development — the industries that created an economic ‘‘bubble’’ whose collapse the country is still recovering from."

http://portal.mfa.kz/portal/page/portal/mfa/en/content/news/ASTANA%20CALLING/2010-05-04


KENYA

As Nairobi Property Prices Rise, Home Buyers Suffer Low Returns
AllAfrica, Feb 22nd 2010

"Many people who have taken mortgages to buy rental properties are finding it increasingly difficult to service the loans since rents accrued are not sufficient to cover the monthly mortgage repayments.
At the heart of the problem is the fact that rents in many parts of Nairobi suburbs are facing a property price bubble."

http://allafrica.com/stories/201002221638.html


ISRAEL

Legal Ground: The end of easy mortgages?
The Jerusalem Post, May 28th 2010

"It was predictable that the Bank of Israel would move to cool the residential mortgage market. We have seen what anarchy of easy mortgages could do to a massive established economy like that of the US. Even more so, the collapse of a bank in a small economy such as Israel could be a disaster."

http://www.jpost.com/Business/Commentary/Article.aspx?id=176747


CANADA

House prices to drop: TD
The Globe and Mail, May 5th 2010

"House prices will fall in 2011, TD Bank said Wednesday as it revised its outlook for the Canadian real estate sector."

http://www.theglobeandmail.com/report-on-business/house-prices-to-drop-td/article1557540


TAIWAN

Taipei Real Estate Risks Grow After Record Rally
Bloomberg, May 20th 2010

"Investors should sell Taipei property now, taking advantage of a 21-month rally in prices before the government acts to make real estate more affordable, according to the Taiwan Real Estate Research Center and the island’s largest real-estate brokerage."

http://www.bloomberg.com/apps/news?pid=20601206&sid=a0cIUQ74Wfy0
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After today’s “hot economies” become tomorrow’s “busted economies” and real estate prices return to normal, the world map of economic health will need to be redrawn. Those with developed infrastructure and the ability to raise taxes will fare better, while emerging markets will likely be hardest hit.

If you have a margin account and/or trade international stocks, it would be wise to raise some cash (if you haven't already), to take advantage of bargains as they come available in the next 18 months.

Despite ongoing domestic problems, it is my belief that in a few years the United States - whose massive deleveraging has preceded and superseded all others - will look enviously safe and stable.

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"...in an environment in which the financial sector is prone to excess and the supervisory structure does not respond sufficiently, the interaction of low interest rates and financial vulnerabilities can clearly be dangerous."

Donald Kohn, Federal Reserve Board, 2010

Abouuuuut….Face!

The CREA Gets Real




Just seven days ago, I wrote an article stating that the Canadian Real Estate Association should be ashamed of themselves for their cheery and completely unrealistic assessment of the Canadian housing market (see: CREA to the Rescue).

Today, in a stunning about-face, the CREA "updated" its forecast, admitting that by 2011 a "demand-driven downturn" will push Canadian home prices lower. They even added that the threat of rising interest rates and new taxes caused buyers to jump into the market sooner than they may have otherwise (something I wrote about in April, in Spending 'til it Hurts).

It’s unclear what prompted the CREA to come clean. I’d like to think it was my blog, but more likely they simply realized that a small dose of reality now prevents egg-on-your-face later.

Of course, the CREA is still being idealistic (read "deceptive"). Amongst other nonsense, they insist that Canada’s "conservative lending practices" and mythical "prudent borrowing" will prevent a large price correction; that the two most overpriced markets (Ontario and B.C.) will inexplicably plateau next year after a small drop; and, of course that the current market shows a good balance between supply and demand. But, at least they aren’t encouraging a new wave of oblivious buyers. The CREA has, with its latest press release, gained back a shred of dignity.

I have to give credit where credit is due: the CREA did the right thing. More of the same would be nice.

For the CREA's full press release, see Housing Forecast Revised.
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"Home sales are coming down from the mountain peak, but they will level out at a high plateau -- a plateau that is higher than previous peaks in the housing cycle.”

David Lereah, Chief Economist, National Association of Realtors, USA 2006

The Canadian Housing Bubble: CREA to the Rescue

In response to a series of headlines suggesting that real estate is overpriced, visibly annoyed members of the Canadian Real Estate Association issued a statement today denying any possibility of a housing bubble, with scores of statistics and beautiful charts to support their claim.

In this article, The Frost Report reviews the CREA's rebuttal (and why they should be ashamed of themselves).

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CREA: “Canada’s solid mortgage market trends, conservative lending practices, and prudent borrowing by home buyers means that Canada will avoid a U.S.-style housing price correction.”

The Frost Report: Canada's conservative lending practices are a myth. In the heat of 2006 Canadian banks were, just like their American counterparts, doing loans without even confirming the borrower’s income. As long as the client’s credit bureau reported the name of the company they claimed to work for, this was considered enough evidence. In addition, although the Canadian Mortgage and Housing Corporation has strict guidelines regarding credit scores and income levels required for approval, a CMHC representative recently told me that they had been making exceptions to the rules "left right and center."
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CREA: The “vast majority” of Canadians have mortgages they can afford.

The Frost Report: Canadians can afford them today because of record low interest rates, which is exactly what caused the bubble to re-expand. For several months now the Bank of Canada has been warning consumers that interest rates will be increasing, and expressing concern about their personal debt levels. From June until Nov 2009, many if not most new mortgages were variable rate; this worried the Bank of Canada as well as the Big 5 banks. As a result, laws were passed stating that all buyers must qualify for a fixed rate even if they intend to take a lower (for the moment) variable rate mortgage.
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CREA: “Over the past 12 months, most new mortgages (64 per cent) have amortization periods of 25 years or less. This is an increase compared to 54 per cent one year ago.”

The Frost Report: The insinuation here is that since people are choosing 25-year mortgages (with higher payments) instead of longer-amortization mortgages, they must have money to spare. In fact, the opposite is true. In the past year home prices have become so high that the majority of home purchases have been from existing homeowners - either selling and repurchasing, or doing equity take-outs to purchase second properties. First time homebuyers are seldom able to afford 25-year amortizations. The decline in longer mortgages means that first time homebuyers are abandoning the market.
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CREA: Twenty five per cent of mortgage holders recently increased their home equity via lump sum payments against the principal and/or by increasing their mortgage payments above their scheduled payment.

The Frost Report: It is not these homeowners, but the 75% of homeowners that do not or cannot make extra payments that is concerning. The CREA's comment ignores that fact that if even a small percentage of homeowners fall behind on their payments it will bring down the entire market. In the United States in Q3 2007, subprime adjustable rate mortgages made up only 6.8% of the market, yet accounted for 43% of foreclosures.
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CREA: Most mortgage holders (77 per cent) have a home equity position of at least 25 per cent.

The Frost Report: This is because until 2006, 25% was the minimum requirement to purchase a home in Canada. At that point, the minimum down payment was changed to 0% in order to boost the housing market. Presumably because of the risks, CHMC pulled the plug on zero down payment mortgages in 2008. The minimum is now 5%.
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CREA: Housing prices will not drop. Instead, personal incomes will rise to match home prices.

The Frost Report: I feel vomit in my mouth right now.
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It's hard to imagine a more biased source of information about real estate than an organization whose purpose is to represent “more than 96,000 real estate Brokers/agents and salespeople working through more than 100 real estate Boards and Associations.” Still, the CREA could do the morally upright thing and at least present the potential downside risks. Due to the CREA's press release, hundreds of dreamy-eyed homebuyers will once again enter the market, oblivious of the dangers.

For more examples of CREA spin-doctoring, see Spin City.

For the full text of the CREA statement from which this article was based, see: Relax: It's Just Another Housing Market Cycle.

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“There is no evidence of a housing ‘bubble’ in the United States and housing demand should stay strong for years to come.”

James F. Smith, Society of Industrial and Office Realtors, 2005
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Spin City

In recent days, both the Canadian Real Estate Association (CREA) and the Canadian Mortgage and Housing Corporation (CMHC) have been coordinating the same message to potential homebuyers: sales have dipped slightly, while listings & housing starts are rebounding, which is leading to an “improved balance between demand and supply.” The result, we are told, will be stable or modestly increasing home prices, simultaneously proving that the bubble everyone was whispering about was false. We can all breath a sigh of relief, and go out to buy that condo.

Personally, I find this spin-doctoring offensive. The CREA argument about supply and demand is rather like arguing that the Nasdaq was not overpriced in 2000, since there was a balance in demand for Internet stocks. In fact, one characteristic of bubbles is that demand suddenly plummets when people realize that there is no one left who wants to buy. So, to know the real story, we have to talk not about supply and demand, but rather about valuation.

By financial standards, a home is considered “comfortably affordable” if monthly mortgage expenses are 32% of pre-tax monthly income or less. As this number increases, one’s standard of living becomes increasingly tenuous. When monthly debt payments reach 40% or more of income (including mortgage payments, car payments and others), financial survival becomes a struggle.

The facts about Canadian housing are straightforward. According to RBC research (November 2009), if a median-income family bought an average 1200 sq ft bungalow in Canada, their monthly payment would be 40.2% of pre-tax income -- well above the 32% recommended, and in fact already above the monthly limit for total debts. In major cities, the numbers look even worse. In Toronto an average home requires 48.6% of pre-tax income: in Vancouver, 66.8%. This effectively means that if an average couple bought an average home in Vancouver, they would pay their income taxes, make their mortgage payment, and have nothing left.

And, the above statistics are the case today. Canadians, normally known for financial prudence and common sense, have actually been increasing their personal debts – not paying them off -- since the credit crisis began. The Bank of Canada stated that, “overall risks to financial stability arising from the household sector have continued to increase.” If current interest rate and savings estimates remain unchanged, Canadian debt payment levels will reach record highs by the fourth quarter of 2011. By the middle of 2012, roughly 1 in 10 Canadian households will have debt payments that leave them “financially vulnerable.”

In order for home prices to remain at current levels, one of the following must occur:

A) All homes and condos built from this point forward must be bought by foreigners/immigrants (since locals are already incapable of safely purchasing homes at today’s prices).
B) Wealthy investors must buy -- and continue to buy -- multiple homes for speculation, and keep them for years.
C) Wages in major cities must increase by approx. 8-30% (depending on the city) within the next 12 months, with no rise in unemployment.
D) Home prices must drop.

I can’t blame the CREA for their rosy interpretation of the numbers; after all, their mandate is to represent “more than 98,000 real estate Brokers/agents and salespeople working through more than 100 real estate boards and Associations.” With such allegiances, it seems unlikely that the CREA would ever say, “we think homes are overpriced and that you should wait to buy one.” Still, for the CREA to pooh-pooh the notion of a real estate bubble by citing supply and demand is either foolhardy or immoral.

Ockham’s Razor states that for any given problem, the simplest explanation is generally the best one: Canadian home prices must drop. For the record, my educated guess (it is only a guess) is that this drop will begin sometime between the 3rd quarter of this year and the 4rth quarter of 2011. And it will be nasty.
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“There is virtually no risk of a national housing bubble based on the fundamental demand for housing and predictable economic factors.” David Lereah, former chief economist of the National Association of Realtors, 2005 U.S.A.
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