Interest Rate Reset Risk

[Greenhorn]

Hi Greenhorn,

Good to hear from you!

My thoughts exactly.

These ultra low rates are a great opportunity to pay down a mortgage. If I was the person in the example, I would up my payments to the highest amount manageable from the get go to pay down as much as possible while rates are low, so that when rates go up, I'd be able to push out the amortization and let the inflation that caused rates to rise, eat away at the relative value of the mortgage.

What are your thoughts?

M

Paying down your mortgage at an accelerated rate with lump sum payments annually, is always an excellent and safe return on investment. The strategy you suggest is an excellent one. When the mortgage matures, you have the option to always increase the mortgage if you require additional cash for other investments. If you have enough equity in your property at the time that you refinance, you may qualify for a line of credit secured by your house, on top of your mortgage.

[metalhead]

This caution could be seen in how rare foreclosures were in my market during the economic crisis.

Hmmm, the way this is worded you seem to think the economic crisis is all over with and it's clear sailing from here on out?
I'm not so convinced.

[pianoexcellence]

Paying down your mortgage at an accelerated rate with lump sum payments annually, is always an excellent and safe return on investment.

For the average homeowner, this is literally the best use of free cash.

[Greenhorn]

This caution could be seen in how rare foreclosures were in my market during the economic crisis.

Hmmm, the way this is worded you seem to think the economic crisis is all over with and it's clear sailing from here on out?
I'm not so convinced.

North America's most expensive real estate, high job losses and interest rates at historical lows are not exactly the ingredients for a recipe of financial prudence. Low rates encourage excessive risk taking and create asset bubbles.

[MikeStewartRealtor]

Hi Greenhorn,

http://www.theglobeandmail.com/globe-in ... le1373545/

Niall Ferguson is saying similar things...

Its clear from low rates the BOC is concerned about what has happened what is continuing to occur. I am betting the BOC will be successful and Canada's economy will be reflated and growth will resume and be sustained. All I can do is bet and hope.

Did you read the Ascent of Money? http://www.mikestewart.ca/blog/2009/01/ ... much-more/

[MultipleOffer]

haha sweet beard Mike... from one scot to another

[MikeStewartRealtor]

Thanks!

My ethnicity is unmistakable when I don't shave for a while...

[grantness]

My thoughts exactly.

These ultra low rates are a great opportunity to pay down a mortgage. If I was the person in the example, I would up my payments to the highest amount manageable from the get go to pay down as much as possible while rates are low, so that when rates go up, I'd be able to push out the amortization and let the inflation that caused rates to rise, eat away at the relative value of the mortgage.

Interesting opinion. When money's cheap, reduce debt ASAP... but as soon as it's expensive, that's a great time to be a borrower?

crazy. I guess it's different in realtor-land.

[Austin]

You might want to revisit that thesis MikeStewart..

If you assume the debt markets are efficient and we're not going to increase rates ahead of what the curve currently predicts, then whether rates are historically low or high is irrelevant.

However if rates are going to go up ahead of schedule then it is less desirable to pay off your mortgage early as there are more likely to be better opportunities out there to invest other than your own mortgage. Basically, you shorted the bond market and won when you locked in your rate and now it's time to take advantage of this. Unfortunately, you still have an income tax hurdle to overcome if it's your own home.

So yes, unless you can declare interest payments against your income (investment property) or you can get significantly better return elsewhere, minimizing amortization as much as possible is usually a good strategy. Conversely, if you are a betting man and think that rates are irrationally low and will soon be going up significantly or you have a great stock tip, now is a fantastic time to lever up as much as possible.

[Greenhorn]

Hi Greenhorn,

http://www.theglobeandmail.com/globe-in ... le1373545/

Niall Ferguson is saying similar things...

Its clear from low rates the BOC is concerned about what has happened what is continuing to occur. I am betting the BOC will be successful and Canada's economy will be reflated and growth will resume and be sustained. All I can do is bet and hope.

Did you read the Ascent of Money? http://www.mikestewart.ca/blog/2009/01/ ... much-more/

Thanks for the links. Those who ignore history are always forced to repeat it.

Now, there is a chance that Vancouver can skate calamity. This is a very livable city and one of the most desirable places in the world to live. Everyone in Canada wishes they can live here and our expensive real estate can be viewed as merely an amenity tax. The price you have to pay for a beautiful, safe, and clean city with a temperate climate.

If Vancouver is truly the playground of the global rich, our real estate prices only have one way to go and that is up. Local incomes and the economy become irrelevant. This is the wild card factor that could make the real estate market not only stable, but stronger.

Can this happen? You tell me. Mike, you are on the front line. Out of every 10 buyers you have dealt with, how many buyers get high ratio financing (5% down)? How many buyers are first time? How many are rich foreigners? How many are poor foreigners (i.e. high ration financing)? How many need dual income? What are you seeing? 80% foreigners buying cash and using Vancouver as a vacation property? How many properties are bought as rentals?

If 90% of your clients are first time buyers with 5% down and a down payment gift from their parents, then I would be worried. If 80% of your customers are rich foreigners, buying Vancouver because they a summer home and are paying cash, then I would say prospects for Vancouver real estate staying strong are pretty good.

[MikeStewartRealtor]

Grantness & Austin - Paying off the mortgage on my primary residence asap, no matter what rates are doing is what my plan is. With ultra low rates, I can pay off huge principal easily. Once that mortgage is gone, its gone.

Hi Greenhorn - You're welcome! I strongly recommend that book. Ferguson predicted the financial crisis quite accurately.

I am very optimistic about Vancouver's prospects and its because of what I see on the front lines.

Out of every 10 buyers you have dealt with, how many buyers get high ratio financing (5% down)? Less than 10% - Most put down at minimum 20% and are not highly leveraged.

How many buyers are first time? 20-30%

How many are rich foreigners? 20-25%

How many are poor foreigners (i.e. high ration financing)? Zero

How many need dual income? 40%

What are you seeing? 80% foreigners buying cash and using Vancouver as a vacation property? 15% of my business

How many properties are bought as rentals? 20%

The people I work with buy and hold because they see big potential for Vancouver. These are discretionary decisions based on Vancouver's quality of life and amenity.

What are your thoughts?

[kansai_92]

Mike,

Thanks for your stats. However, you probably deal with a narrow segment of the market.
For the overall Vancouver market, high ratio mortgages are much more prevalent than 1 in 10.

[MikeStewartRealtor]

Hi Kansai,

You might be right, but what I find is that when people feel they can't afford Vancouver, they go out to the burbs.

Keep in mind those CMHC premiums. if you're going super high ratio, the CMHC premiums are as much as or often higher than the down-payment.

I haven't met too many people willing to put that small an amount down on their mortgage and pay those high premiums to live in Vancouver.

[Austin]

Grantness & Austin - Paying off the mortgage on my primary residence asap, no matter what rates are doing is what my plan is. With ultra low rates, I can pay off huge principal easily. Once that mortgage is gone, its gone.

Mike, I suggest you re-check that math regarding "with ultra low rates, I can pay off huge principal easily." before repeating it to your customers. Just some friendly advice.

Paying off the mortgage on my primary residence asap, no matter what rates are doing is what my plan is.

This is only a good plan if you can't get superior returns on your money or you can't time the bond market, which is frequently true if investing isn't your forte so it's usually good advice. However, you suggested earlier to time the bond market depending on 'ultra low rates', so you're kind of contradicting yourself.

[Austin]

Keep in mind those CMHC premiums. if you're going super high ratio, the CMHC premiums are as much as or often higher than the down-payment.

By super high, you mean less than 3.1% down. At that point though, you don't really have a down payment..