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Negative equity is a concept Canadian homeowners have not had to deal with in decades, but rising interest rates and falling real estate prices now have advisors bracing for a wave of clients with homes worth considerably less than what they owe their mortgage lenders.
In April, shortly after the Bank of Canada raised interest rates for the second time this year, an Ipsos poll conducted on behalf of Manulife Bank of Canada found almost a quarter (23 per cent) of homeowners with a mortgage said they’re at risk of being forced to sell their home if interest rates were to rise even further. The survey did not specify how much interest rates would have to climb to trigger widespread forced sales.
But the central bank has hiked interest rates twice since the survey was conducted, including its first 100-basis-point increase since 1998 last week.
While it will take time for those higher rates to translate into higher mortgage costs as most homeowners have fixed payments, Wendy Brookhouse, founder and chief executive officer of Black Star Wealth in Halifax, points to getting ahead of the problem.
“For some people, the problem could be another four years away, but they can start absorbing some of that pain now,” she says.
“If you already know that your mortgage rate is probably going up whenever you renew, then you can start increasing your payments now so that when you do need to renew, not only does the payment stay closer to what you’re already used to, but [the extra payments you’re making now] also decrease the principal a bit more.”
There are also creative ways to keep interest payments as low as possible by looking beyond the traditional fixed or variable rate options for mortgages, Ms. Brookhouse says. Some lenders offer tiered mortgages that break the principal loan into five pieces with fixed terms ranging from one to five years.
“That way, every year, one-fifth of your mortgage is going to come up for renewal with the lowest possible rates,” she says.
How to increase cash flow for higher payments
For clients who simply don’t have more cash to put toward their mortgage, there are also lessons to be learned from history.
“If we think back to how a lot of people got into the housing market years ago, it was by having roommates,” Ms. Brookhouse says. “It might be the time when we have to do that kind of thing again.”
Kelly Ho, certified financial planner and partner at DLD Financial Group Ltd. in Vancouver, says the relative ubiquity of income suites on the west coast makes the roommate option easier.
“In Vancouver, we have basements, dual basements, coach houses – we have a lot of options,” Ms. Ho says. “A lot of people who buy homes here have the option of having tenants, but a lot of people don’t like that idea.”
Yet, if it’s a matter of having some tenants in your home versus losing your home altogether, most people would choose to have tenants, she adds.
Downsizing to a less expensive home is also a popular option for homeowners looking to offset higher interest rates, Ms. Ho says. However, for those in a negative equity situation, such a move may not be feasible.
An alternative option could be renting out their existing home and using part of that income to find a less expensive place to live temporarily while the rest goes toward their mortgage, Ms. Ho says.
“Selling your home is a very permanent thing, and given the volatility of the interest rate situation, people need to ask themselves if they really want to make such a permanent change so quickly that they will not be able to reverse,” she says.
Before taking such drastic measures, Ms. Ho says advisors can play a key role in helping clients determine whether they truly cannot afford higher mortgage payments.
“A lot of Canadians believe they need to have a vacation every year – that vacation spending is absolutely necessary,” she says. “[But] if it’s a question of keeping your annual vacation or keeping your home, that should be an easy call. Unfortunately, sometimes, from what I see, it’s not – until you are told to your face ‘You’re going to lose your home.’”
Can clients wait it out?
Still, it would take years before a large proportion of homeowners find themselves in a negative equity situation.
Ms. Brookhouse notes that “negative equity is only negative if you sell,” adding homeowners should do what they can to wait it out until the market rebounds, given the ongoing lack of housing supply.
However, Hilliard MacBeth, financial advisor in Edmonton and author of the 2015 book When the Bubble Bursts: Surviving the Canadian Real Estate Crash, warns waiting might not be an option for homeowners who bought during the recent pandemic-fuelled buying frenzy.
”Anybody who bought in the past couple of years is probably very vulnerable to negative equity fairly quickly,” he says.
“If you look at some of those suburban markets around Toronto, there are tons of people that bought a home for $1.5-million who now can’t sell it for $1.2-million.”
Mr. MacBeth adds that unless they put a substantial down payment of well over 20 per cent, which he doubts, they’re already in negative equity.
If any of those homeowners encounter life events such as an illness or job loss and need to sell their home, “they’re now in real trouble,” he says.
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