Vancouver Investment Adviser On ‘Threat Of Home Ownership’ – “This is my 15th RRSP season. I have never seen so many couples under financial stress. It’s a new form of slavery.”

“This is my 15th RRSP season,” said Ernesto Salvi, an investment adviser with Edward Jones in Vancouver, “I have never seen so many couples under financial stress.”
Couples in their 30s through 50s are having trouble contributing anything at all to their registered retirement savings plan, he said recently in an interview over the phone. And then he talked about how buying a house these days won’t just put you at risk of having to ignore saving for retirement. You might also find that you’re forced to dip into your retirement savings just to get by.

Mr. Salvi has a client who is married with four kids and a house in the suburbs that was purchased a few years ago. Over the previous decade, she had built a small registered retirement savings plan of about $30,000.
In February, Mr. Salvi called this client to remind her about the upcoming RRSP contribution deadline. “She said, ‘You know, I cannot put anything into my RRSP and, by the way, I need to cash it in.’”
Mr. Salvi recalls warning her about the withholding tax that applies to money withdrawn from an RRSP. Her reply was that her RRSP was her last resort. “The sad thing is that it took years to grow that RRSP, and it’s going to be used up in a few months.”

On the surface, it sounds like the house is only part of the problem for this client and her husband. In addition to a large mortgage, they had a heavily used home-equity line of credit, maxed out credit cards and two car loans, Mr. Salvi said.
The house was the killer, though. When you buy a house, you generate wants and needs that weren’t there before. Got a house in the suburbs? Suddenly, you’re a two-car family. Moving up to a house from an apartment? You’ll need furniture, window coverings, carpets, electronics, lawn and yard equipment. Affording it all is easy. Buying a house means you can set up a home-equity line of credit, where you borrow at low interest rates by tapping into the equity in your home. If necessary, credit cards can help you supplement your borrowing.

RRSPs are road kill here. People use them to buy homes through the federal Home Buyers Plan and, as Mr. Salvi’s story shows, they may dip into them again just to get by.
In fact, many of Mr. Salvi’s clients are struggling to cope with the cost of carrying a house and other debts. He sees homeowners who are typically paying as much as $3,000 or more per month in mortgage payments. Not surprisingly, the clients who made lump-sum contributions to their retirement savings this past RRSP season tended to be on the older side.

“All the big cheques came from people over 60,” he said. “It’s the crowd between 30 and 50 that didn’t contribute. Some of them I’ve pushed to do it monthly because it’s easier on their budget. What I didn’t see this year is the extra amount at the end of February.”

Ironically, this is the year the federal government has added to the retirement burden of young adults who are just getting into the housing market. Starting in 2029, they’ll have to be 67 to collect Old Age Security, which right now pays a maximum of $6,481 per year starting at age 65. You need to save more to cover this loss of benefits, or you can stay in the work force for a few extra years. If you buy a home in cities like Vancouver and Toronto, you might just be making an implicit choice to work longer.

Mr. Salvi has seen what happens when people buy houses they can’t really afford and find that debt rules their lives. “It’s a new form of slavery,” he said. “That’s how I see it personally.”

– from ‘The hidden threat of home ownership’, Rob Carrick, Globe and Mail, 9 Apr 2012

Many Vancouver homeowners are over-invested in RE and sorely unprepared for retirement. Home price increases have allowed for debt-driven consumption, over-spending based on wealth-effect, and neglect of non-RE investments. All part of the misallocation of resources that occurs in a speculative mania in housing.
– vreaa

12 responses to “Vancouver Investment Adviser On ‘Threat Of Home Ownership’ – “This is my 15th RRSP season. I have never seen so many couples under financial stress. It’s a new form of slavery.”

  1. The sad thing is, when it comes to choosing between RRSP contribution, Mortage payment and kids education, you’re advised by the local media to pay off the mortgage as soon as possible, regardless of the risks…

    The big question: What to pay first? Mortgage, kids’ education or retirement?

    “Pay for the home first,” suggests Benoit Poliquin, lead portfolio manager at ExPonent Investment Management Inc. in Ottawa. The reason: Buying your home quickly has financial advantages so powerful and so immediate that it would be foolish to ignore it.

    “Look what the homeowner gets,” Mr. Poliquin says. “There is the return on equity. That is what the home gains in owner equity every month as the debt declines [provided the house doesn’t decline in value… ask our friends on the island]. The more you pay and the sooner you pay, the faster you gain equity through the mortgage.”

    There is the possibility of capital gains that, in Canada, are not taxed as long as the home is a primary residence. Moreover, in many cities, price gains more than pay for interest costs, says Graeme Egan, a financial planner and portfolio manager at KCM Wealth Management Inc. in Vancouver. [what happened in the past is surely an indication of what will happen in the future I suppose…]

    On top of probable price gains, there is the tax advantage [paying property taxes is now considered an advantage… what a wonderful world we live in…]. Today, if you pay 3.5% on a five-year mortgage and you have a 40% tax rate, your actual cost of paying the mortgage with after-tax dollars is 5%, Mr. Poliquin says. “The rational thing is to pay the mortgage while your income is lower, though it may be harder. As your tax rate rises, the after-tax cost of the mortgage goes up.”

    http://www.vancouversun.com/business/mortgages/question+What+first+Mortgage+kids+education+retirement/6420728/story.html

    • Ralph Cramdown

      Quite the financial planners. There’s a big difference between paying your mortgage early at 3.5% vs. 7%. Max out your RRSP and TFSA contributions, and make sure they’re invested in performing assets. You’ve got the same amount invested in your house whether you’ve got 20% equity or 50%, but in one case your money is working elsewhere, and in another it’s dead.

    • “There is the return on equity. That is what the home gains in owner equity every month as the debt declines”

      This doesn’t make sense to me. Your return on equity should be something like the rent you save minus interest and property taxes. Obviously as you pay for the house your payments shrink and your “return on equity” gets better, but if you start out with payments much higher than rent how long does it take to get a positive return? It seems to me that if the premium is small and prices never fall you can come out ok, but if the premium is large and prices revert to the mean then you won’t beat someone who simply saves the difference.

      • Ralph Cramdown

        As you pay down the mortgage, you’re paying less in interest each month, so your expenses go down, though the monthly payment doesn’t change. As you build equity, the denominator in the ROE calculation is getting bigger, so your ROE actually decreases. That’s why speculators like lots of leverage. They call it OPM, or Other Peoples’ Money.

      • Leverage ratios do eventually matter. It sometimes takes a bit more time with some kids, as one of my teachers liked to say.

  2. Also, don’t forget that when you borrow money from your RRSP to get your down payment, you’ve got to repay it into your RRSP within 5 years (I think it’s 5 years– something like that, anyway), or you get back-taxed on it…

  3. Told-you-so-in-2007

    Ha!

    “There is the return on equity. That is what the home gains in owner equity every month as the debt declines”

    Let’s say a first-time homeowner assumes a $500,000 mortgage amortized over 30 years at an historically low 4% over a 5-year term. This person will have $452,000 owing on the principal when the rate resets in 5 years. So yes, they will have $48K of “equity”, despite having paid in over $142,656 in payments ($2377.60 a month x 60 months) over those 5 years.

    So, assuming over they time span of 5 years:
    a) the value of the house doesn’t fall more than $48K (the value of their “equity”), and
    b) they haven’t refinanced the house already to pay the bills, and
    c) interest rates don’t increase much, ballooning their monthly payment higher,

    …they might not be too screwed. Yay!!! *rolls eyes*

  4. the safest way is to hide under your bed!

  5. didn’t anyone link this yet? the article came out this am
    http://www.crea.ca/content/national-home-sales-rise-march
    nice charty thing embedded there

    • Ralph Cramdown

      Some pretty impressive data mining there. I wonder if the banks will want to emulate that tour de force in a few years; “And here’s our mortgage portfolio ex Vancouver and Toronto.”

  6. Mr. Salvi’s story is mind numbing reading. The money coming out of RRSP’s will take its toll on the stockmarket.

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