Protect Your Equity When Real Estate Prices Drop

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Besides the resulting slight increase in property taxes, let’s be honest – homeowners love learning that the house down the street recently sold for “x” over asking. Upon hearing the news, we can’t help but think – and hope – that our own Toronto townhouse, condo or detached is now worth the new “inflated price”. We start thinking of retiring sooner, travelling, and buying all the things we’ve always wanted but couldn’t afford.

The Sky Isn’t Falling

But what happens when property prices in your neighbourhood start to decrease? Well, the pigs begin to fly, and the sky starts to fall! Before making a knee jerk reaction like listing your home and renting an apartment, though, hold tight.

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Keep in mind that the government has been prudent in enacting measures to protect – or at least warn – Canadians from fluctuating real estate prices, low interest rates, and risky debt loads.

Some of the changes recently introduce include how mortgages are approved, the implementation of the new Land Transfer Tax (2009), and adding HST to newly built homes. All of these measures have limiting effects on what a borrower can afford to spend on a home.

Other measures taken out by the government include:

New rules implemented by bank regulators that disqualify high-ratio (less than 20 per cent down) mortgages on homes above $1 million, 30-year amortizations, and rental properties.
The Bank of Canada’s lending “stress test” which requires borrowers to qualify at a mortgage rate of 4.64 per cent.
Requiring a minimum 10 per cent down payment on purchase amounts between $500,000 to $999,999.
Increasing rates by up to 150 basis points for “B-side” or “alternative” lenders – those who provide mortgage financing outside of the common lending practices, and catering to Canadians with below-average credit.
Many warnings issued by the Canada Mortgage and Housing Corporation, which is a governmentally-backed high-ratio mortgage insurance provider, that house prices may be overvalued in some Canadian marketplaces.

Looking to the Past

While no one has a crystal ball, one of the best ways to gain insight to the current market is to look to the past. Analyzing Toronto Real Estate Board data, we can see there have been a few house price spikes and drops over the years, similar to what we’re experiencing today. They occurred in the 1950’s, 1974, 1989, and a slight bump in 2008. The average timeframe for the house prices to exceed the average increase after a house price spike is around nine years.

What does this mean for today’s home buyer? Let’s say you’re bidding on a home for purchase, and the bid is getting out of control. You need to use your best judgement on a) whether you can really afford the home and b) you’re be ok with living there for the next nine years or so should the market soften.

Is It The Right Time to Buy?

If you can’t financially sustain the chance of a price drop, or are leveraged above your means – meaning your mortgage will be 90 – 95 per cent of the current home value – it’s likely you best you forgo the current inflating purchase bid. Rent or live with family for longer, take steps to save a larger down payment, or look at more affordable options such as Toronto condos.

How Homeowners Can Protect Themselves

Current homeowners, however, are urged to pay down their personal debts as much as possible, and to take advantage of mortgage pre-payment to pay off your principal faster. These measures will help you ride out the storm of falling home prices, and set you on the right financial track once your equity starts to build once more.