One of the things that continues to fascinate me is the talk of a housing bubble in Canada. With both the Bank of Canada and our finance minister Jim Flaherty foretelling of increasing interest rates on the horizon there is much speculation going on in regards to the sale price of houses. I find one of the most over-looked facts is just how the market determines what a house (or condo) will sell for.
It has been my observation that the actual selling price very rarely factors in to the decision making process for most people. Given it is almost unheard of for someone to purchase a home in cash (without taking out a mortgage) the focus on the purchase price gives way to the focus on the actual monthly cost of ownership.
Through the last decade or so housing prices have changed pretty dramatically though the average take home pay of Canadians has not changed all that much. I think if you look at the overall trends the amount of money being shelled out each month for home ownership has not actually changed all that much. What we have seen though have been significant decreases in interest rates combined with (for a time) extended amortization periods and reduced down payments. It was not that long ago where you could get a mortgage for around 2% interest and a 40 year amortization.
So if you take the average family who has say for example $2000 per month to spend on housing (mortgage, taxes, strata fees, maintenance ect…). In the year 2000 maybe that gave them the ability to spend $250,000 on a house or condo (this is an estimate for illustrative purposes only). Fast forward to 2009 when the same $2000 per month would give them the ability to spend say $400,000 on a house or condo. In both cases they were probably shopping for the same house or condo in the same neighbourhood. Yes the purchase price changed pretty dramatically, but it terms of what it costs you every month and what you end up with in the end it is all about the same.
Do I think the purchase price of houses are going to drop in the near future? The answer is almost certainly yes.
Do I think it is the doom and gloom some so called experts are predicting? No, I really think that is unlikely.
If you are worried about the impact of interests rates changing you still have time to lock in. The only people I see really at risk of being severely impacted by this are speculators who are in the flipping game (one very few people should be in) or those who are looking to get out of the home market all together.
In closing however I do find it amusing that the one thing people seem to pay attention to the most (purchase price) is often the item that has the least effect on them long term.
Purchase something for $400,000 at 3% APR and a 30 amortization will cost you about $1900 per month and total cost including interest by the time it is paid off will be about $568,000.
Purchase the same place for $300,000 at 6% APR (our historical average) it will cost you the same $1900 per month and total cost including interest will be about $576,000.
Which scenario is better? I will let you be the judge of that one!