Hat tip to Rick for sending this along, from the WaPo:
TORONTO — When he bought a home last week with a 40 percent down payment, lawyer Kevin Fritz didn’t see the transaction as particularly relevant to the debate over global financial stability.
But consider: With U.S. home sales and prices still shaky, Fritz bought in a Canadian market that already has rebounded beyond pre-crisis levels. Without the key tax advantages available to U.S. home buyers, he amassed as much as possible for the down payment, and he expects to pay off his 15-year mortgage with the same bank that gave him the loan — a rarity in the United States, where finance companies typically resell mortgages.
“Canadians are debt-averse,” said Fritz, an attitude that’s part cultural and part shaped by banking practices and regulations designed to keep people out of homes unless they can clearly afford them. “People here don’t leverage.”
Canadian tax law is neutral: Interest on mortgage payments is not deductible, a fact that encourages home buyers to make larger down payments and avoid withdrawing equity. The banks themselves expect to hold on to the mortgages they make and collect the interest. Most loans allow interest rates to be reset after five years, and most also carry prepayment penalties — rare in the United States.
The result is a market that appeared sluggish when the U.S. property bubble was inflating but “has been rational” throughout, said Craig Alexander, TD Bank’s chief economist.
“Fundamentally, what we have seen is the Canadian housing market responding to the dynamics of supply and demand,” Alexander said. He contrasted that with a U.S. housing market driven by loose lending standards and by Wall Street demand for mortgages to be bundled and sold as securities: “The mortgages made in Canada are mortgages that banks are quite happy to keep on their balance sheets.”
Subprime mortgages in Canada accounted for only about 5 percent of the loans originated by local banks during the housing boom, compared with more than 20 percent in the United States.
And while U.S. housing has remained sluggish, the Canadian market is showing so much life that the Bank of Canada recently raised interest rates and regulators have taken other steps to temper demand — for example, tightening mortgage qualification rules.
Pamela Alexander, managing director in Canada for the Re/Max real estate firm, said her brokers complained when those actions were taken.
“I said: Be happy it is happening,” she said. “It will be short-term pain. But it means a long-term market.”
Not only does Canada present a better model as an example for other countries, individuals can exercise the same basic principles when considering a personal home purchase and mortgage scheme.
We originally financed with a 10 yr., paying off in just 4.5. No prepayment or early payoff penalty clauses (made sure there wern’t any in the contract), also had a slightly larger down than the example in this article.
Compounding interest is the enemy. Why pay a total of 300% for something, when 120% or less will do. Persoanly, I’d rather save all that interest expense, build equity faster, and forego the tax benes, than be tied to a 30 year.
http://creastats.crea.ca/natl/
Yea, those charts look nothing like the US’s RE charts circa ~2006ish
Now contrast the responsible Canadian model with the American Way:
http://www.youtube.com/watch?v=VL3KuaFvOSc
Steve Martin’s expression of cluelessness – priceless.
Skit in full – http://www.hulu.com/watch/1389/saturday-night-live-dont-buy-stuff
Completely agreed. That said, I’m very debt averse but if the law says I can deduct interest than I’ll be taking full advantage of that. Can’t help but live by the law here.
At all times, you have to compare your mortgage rate with the market returns. To use an extreme example, if CD rates went back to 10% like they were in the past, you’d be better off dumping money into there rather than paying off your mortgage. Easy arbitrage even after tax considerations.
What the hell? So we’re looking up to Canada as a financial example. Isn’t this the same country that was 60 cents on the dollar only 15 years ago?
Thank you federal reserve! Maybe in another 15 years we can look up to Mexico.
Dare to dream…
Now I know why when the Canadians come to Maui they pay cash. Some is oil money but some has to do with their Tax laws.
Thanks Jim for the education.
Yeah, if only CD rates were 10%, not since ’85, and how about those 30 year fix rates back then 13% (approx according to historical data charts). CD rates are currently 2% with mortgage rates at 4.76% (approx same data charts). It’s all relative.
Sol- You don’t have the finance quite right.
Pay expensive debt back as soon as possible. Delay paying cheap debt back as long as possible.
“Why pay a total of 300% for something, when 120% or less will do.”
You forgot to include time and opportunity cost.
One thing debt does not do, however, is create equity. Simply put, equity is a result of greater income than expenses.
Canadian banks do not hold on to the mortgages they issue anymore, this article is completely wrong. There is a government entity called the CMHC, the Canadian Mortgage and Housing Corporation that issues bonds and uses the money to buy mortgages from the banks. Historically the CMHC only bought a small percentage of the mortgages, but over the last two years it has become 95% because the banks in Canada know the market is going to crash and anyone who bought in the last couple of years is in big trouble. 40% down payments are the rarity in Canada these days not the normal.
Our little friends up north are really shoveling out the moose excrement. Apparently you haven’t seen Property Virgins. I can tell you that Canada is very bubblicious.
Crack Shack or Mansion II
Can you tell a Vancouver crack shack from a million dollar mansion, Jim?
http://crackshackormansion.com/
“You don’t have the finance quite right.”
You’re right, I don’t have finance. I paid all the expensive debt off first, then I whittled away at the less expensive debt, now I have no debt. If I had it to do over, I’d have done it faster. The reduction of debt facilitated greater income to expenses thus resulting in a position of total equity.
Wickedheart,
I was in Vancouver about 2 years ago and saw with my own eyes exactly what you’re talking about. EVERYONE was excited about housing even on the local tv news and radio. Felt like San Francisco about 5 years previous.
About 3 months ago I was in Calgary and all people there could talk about was buying foreclosure properties in Phoenix and Tucson.
1 month ago I was in Tucson and I was hanging out with some realtor friends and they were talking about all the Canadians they were selling houses to.
It would be interesting to go back to Vancouver today to see if the frenzy is still in full force.
Sol- “The reduction of debt facilitated greater income to expenses thus resulting in a position of total equity.”
When you say, “total equity,” what you really mean is zero liability, or A=E. The problem is that a rational player seeks to maximize “total equity,” which often includes the use of debt.
To maximize “total equity” a rational player seeks positive leverage, and when the housing market was going up by 10% or more per year, it was not difficult to do. Yes, there is risk. The question is about risk adjusted returns. Real estate was generally viewed to be near risk-free, yet the returns were very attractive.
shadash-
A little fun for you:
http://crackshackormansion.com/
Have to agree with many of the posters, this article seems way off: Vancouver, Toronto & Calgary are major urban centres in Canada and all three are very, very “Bubblious”.
Vancouver & “TO” crashed hard when Canada entered its “Dark Debt Ages” (a la Greece/PIIGS) back in the early 1990s (USA in 2012?). Calgary booms & busts regularly with the oil industry (a la Houston). Today the country is obviously on a roll, but nothing lasts forever.
The lack of a Tax deduction for the mortgage is true, but hardly a positive. Furthermore, there is a technique known as the “Smith Maneuver” (PS: Google for details) that allows any Canadian who wants to turn their house debt into a tax deduction… on the upside the proceeds must be invested in something more substantial than a new BMW, but it still increases leveraged household (tax deductible) debt.
Overall, Canada is not much of a “financial test case” for you. The Financial system here was built on a Scottish Model while yours was built on an English Model (few centralized banks vs many local/regional banks.. neither is perfect).
Couple of points:
1. Mortgages were harder to get until the Conservatives got into power and started wanting to copy the US alphabet soup mortgages. They also let in GE Capital etc to help goose mortgage insurance. Thankfully they may have been slow enough not to do too much damage, but they have definitely done some.
2. Vancouver is a special case (not that big a place) with a lot of Asian investors. Yes the prices are stupid, but have been for 20 years.
3. Canadians also do not tend to move as much as Americans. By staying in their home longer they are building up more equity over time, so the average Canadian likely is a lot further from being underwater.
4. It is not just with mortgages. After the 1990 ish financial scare Canada got its act together and ran surpluses. As a result the C$ has risen and rates here have fallen faster. Rates in Canada always used to be higher than in the US until recently. Now prime is lower in Canada.
Trade offer to the anti-government types here: I’ll trade you non-deductible mortgages for single payer health care and 40 percent taxes. Deal?
Story time! 🙂
In my last mortgage, I was allowed to make prepayments up to a fixed amount per year without penalty. So while I might not necessarily have been able to pay off the mortgage in its entirety as soon as I could without incurring a penalty, I could still significantly cut down the number of years that mortgage would have hung over my head.
And because my last mortgage was also my first, I qualified for the first time home buyer’s plan where you can use money from a Registered Retirement Savings Plan (RRSP) to make the down payment which, as a first time home buyer, was set to 5% instead of 10%.
If you didn’t have an RRSP, you could get an RRSP specific loan for three months, and use the huge tax refund you get from the government as the down payment.
After three months, the loan is paid in full with the money from the RRSP. And after a two year grace period, you must then either recontribute 1/15th of your original RRSP withdrawal back into another RRSP for the next fifteen years, or pay the income tax due on that 1/15th for the years you don’t make a contribution since that 1/15th now qualifies as income.
I sold the place some eight years later for more than double what I originally paid for it. And because my business isn’t making enough money yet, my yearly personal income (including the 1/15th) is below my personal deductions, which means I pay no tax.
All this is perfectly legal, all sanctioned and managed by the government, with no strategic defaults or bankruptcies required.
I’m pretty happy with our system.