As the world slowly returns to normal — a new one, anyway — some might be celebrating, while others might be finding themselves coping with a few unseemly debts.
Despite there being a house-buying frenzy in Canada during much of the pandemic, thanks in part to incredibly low mortgage rates, reality has now set in.
According to a recent survey conducted by Ipsos on behalf of accounting firm MNP LTD, 33% of Ontarians said the pandemic worsened their debt or created a larger debt burden for either themselves or their family, while 31% of homeowners reported being "house poor."
This is a term that gets thrown around a lot in discussions about the housing market and personal finance, but what does it mean? And as a recent or aspiring homeowner, how can you avoid becoming house poor?
How does one become house poor?
If you’re house poor, you’re a homeowner who doesn't have much (or maybe any) money left over each month after home-related bills.
The rule of thumb has long been that your mortgage payments should amount to about 25% of your monthly take-home pay. This number can go up to 30% if you don’t have debt, but if you’re spending significantly more than that on mortgage payments, property taxes, utilities, and general maintenance, you might be house poor. In other words, you're spending more than you probably should on your home.
Maybe you've run into unexpected circumstances, like a job loss for you or your partner. Either way, there's an imbalance and it's the house that's weighing you down. You can easily find yourself in this situation if you purchase a home outside your means, or because you didn't account for all the utility and maintenance costs that would come with it, which might be depleting your savings. Eventually, that could put you in a position where you go into debt for anything from buying groceries to making car payments.
You start to tell yourself stories of how you can make this work
"We're seeing this increasingly in the market these days, where people are effectively over-stretching to buy real estate," says David O'Leary, founder of Etobicoke-based financial planning company Kind Wealth.
O’Leary says there are many reasons this can happen, including behavioural ones. "There's not a person alive who hasn't gone searching for a new home with a budget in mind of what they can afford, and as they start looking, the homes that are at the top end of their budget look a lot more appealing than the homes that are at the lower end.”
“So, you're constantly stretching, and you think, 'Well, it's an investment, it can't be that bad, I'm going to live there.' You start to tell yourself stories of how you can make this work."
How can you avoid becoming house poor?
The key thing to do before buying property is to always do your research. And then do it again. An emergency fund for if and when you run into trouble is always beneficial, as is paying off other debts before buying. It also never hurts to ask for help and get a second opinion by working with a financial planner who can walk you through the basics, including your budget and the kinds of short-term and long-term costs you might run into by being a homeowner.
But, says O'Leary, before you buy, you've got to ask yourself: Is buying a home right now right for me?
"Oftentimes, we get caught up in the race or the pressure of the real estate market,” he says. “It's a 'this is what I'm supposed to do' mentality. But whether it's right for you to buy a home or not depends on your particular circumstances. As property prices continue to escalate, the economics of buying a home start to become more tenuous. After a while, you might start to wonder, 'Is this worth the price that I'm paying?', and that's a difficult question to answer."
For the record, O'Leary says if you're spending 50% of your monthly net pay on your mortgage, you're in trouble.
How will rising mortgage rates affect you if you’re already house poor?
According to a September report from Equifax, Canadians are carrying a hefty $2.15 trillion in consumer debt, and took out 410,000 home loans in the second quarter of the year, which marks the highest volume recorded in a single quarter — ever.
With mortgage rates rising, it's those with a variable-rate mortgage who will be affected immediately. For those on a fixed-rate mortgage, it depends on how long you have until your term comes up for renewal, and where rates will be then. And five-year fixed rates have already started their ascent.
There's only so many tips and tricks, only so far you can go when you've really over-leveraged yourself
"If you just got a new home and locked in for a five-year term, as interest rates go up you'll be fine for the first five years," says O'Leary. "But no one should be shocked if, at the end of five years, rates are still higher than when they first secured that mortgage.
"Since the early to mid-1980s, we've been on a long-term decline in interest rates. They've obviously gone up and down along the way, but you could draw an almost straight line down from interest rates in the '80s to now. If that can happen in that direction, you can certainly go back the other way. But of course, no one has a crystal ball."
Is there a way to get out of being house poor?
If you are currently house poor, first, take a breath. See if there are expenses you can cut, sacrifices you can make, or if you have additional ways of adding to your income (i.e. pick up more work, rent out a room or basement).
If you're in a variable-rate mortgage, consider moving to a fixed term when your mortgage term renews. While that would mean a higher interest rate and mortgage payment in the short term, it will give you protection for the next five years as rates rise.
"If you've really got yourself in a difficult situation, and given how quickly real estate prices are rising, selling the property is a possibility," adds O'Leary. "If you sell, you might get a price high enough to cover all your costs, and then consider downsizing or even renting. I've seen many people in some really challenging situations where there's only so many tips and tricks, only so far you can go when you've really over-leveraged yourself."
If you do choose to sell, there is an upside: you can find a home in a more affordable neighbourhood, for example, and not have to cut back on other expenses or adjust your financial goals as you had to before. Whatever you do, just don't wait until the last possible moment when you're especially desperate — act now.
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