A few weeks ago—after spending much of the last decade warning readers against the perils of Canada’s overheated housing market—I did the unthinkable: I bought a place. When I told MoneySense investing columnist Norm Rothery, he was dismayed. Didn’t I know that homes in Toronto are way overpriced? Why would any sane person pay such a ridiculous sum for such a tiny shack?
He has a point. Canadian homes are indeed rather pricey by almost any measure: the cost of buying versus renting, historical house price trends, even by basic affordability measures. I have predicted several times that the market is due for a nasty 20% correction. So how could I—a happy renter for many years—suddenly turn around and squander my life savings on an overpriced pile of bricks?
The reason is simple: I want to eventually retire with a paid-off house, and I was running out of time. Besides, I don’t see my house as an investment, as a means to an end. It’s a purchase—it’s what I’ve been saving my money for. But I haven’t completely lost my mind. I did do some risk analysis before buying. If you’re wondering whether your house purchase is at risk, read on for three easy tests to find out how safe you really are.
Can you afford it? Rather than assuming I could afford my house because they approved my mortgage, I decided to subject my finances to a more rigorous test recommended by the Globe and Mail’s Rob Carrick. He advises that you take your after-tax monthly income and subtract not only the mortgage payment on your new house, but all of your other non-discretionary monthly payments, such as property taxes, utilities, car loan payments, daycare fees, home maintenance costs, and even 10% for retirement savings. If the percentage of your income consumed by those costs is 75% or less, you can do it. If not, you’re taking a risk. (For the record, I passed.)
What happens if house prices plunge? I still think we could see house prices drop by 20% in the medium term, so I decided to model what would happen if they did. I’m not planning to sell for at least 20 years, so I’m not concerned about my home’s short-term resale value. My big concern is ending up “under water.” That’s what happens if your house price drops so dramatically you owe more on your mortgage than your house is worth. Because your bank views your house as collateral for its loan, you could have trouble renewing your mortgage. The solution was a cushion in the form of a large down payment. If you make a down payment of 20%, you can withstand a 20% drop without any issues, and as a bonus, you don’t have to pay CMHC mortgage insurance either.
What if interest rates suddenly jump? The last big risk is a hike in rates. You can protect yourself in the short term by taking out a fixed-rate mortgage. (Mine was the standard five-year fixed variety.) But eventually you have to renew, and rates could be much higher by then. So I visited an online mortgage rate calculator and looked at what my monthly payments would be if rates doubled. I could still afford my payments, but I could see rates going even higher, so I plan to aggressively pay down my mortgage with pre-payments (extra payments) over the next five years to give myself some wiggle room.
So do I feel like I got a good deal on my house? Not at all. By historical measures, I overpaid by quite a bit. But it was either that or no house at all, and I don’t regret my decision—in fact I love my new house. Of course, now that I’ve finally bought, house prices are sure to plunge, but the important thing is I’ll be okay if they do.