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decoding the mortgage market

Few people would walk even a 10-foot-high tightrope without a net. Even with a reward, the fall wouldn't be worth it if something went wrong.

Yet people who buy homes without access to emergency funds are walking a figurative tightrope every day.

When you get a mortgage with no savings, the unforeseen is your enemy. Things such as a job loss, drop in income, home expense, divorce or medical problem can come out of nowhere. No one expects misfortune but it pays to be prepared with at least three months of living expenses set aside.

But not everyone heeds this advice: A recent CIBC survey on contingency funds found that 40 per cent of Canadians with mortgages have no emergency savings.

For tapped-out homeowners with no savings or borrowing power, an unexpected $5,000 to $10,000 expense can quickly put them at risk of missing a mortgage payment. Luckily, the number of people in that precarious boat is nowhere near 40 per cent of mortgage holders. But it's not an immaterial number either.

Either way, the thought of being escorted off one's property by a court officer makes people go to amazing lengths to avoid foreclosure. When times get tough, folks with no savings will beg, steal or most likely borrow to make their mortgage payments. They take cash advances from their credit card, hit up friends or family, sell assets, borrow from a line of credit, or scramble to get a second job.

As far as credit card cash advances go, that's not a backup plan. If 20-per-cent interest credit cards are a homeowner's only source of liquidity, they're better off renting. Climbing out of a high-interest debt hole takes way too long and costs far too much.

Borrowing from others is also a poor contingency plan. For one thing, it's unreliable. For another, it can add considerable stress to personal relationships.

Selling assets to raise cash is another option, depending on your holdings. Though it's often a question of how fast you can liquidate the asset, as well as any tax or retirement ramifications.

The most popular failsafe for Canadians who can't make a mortgage payment and don't have savings is the home equity line of credit (HELOC). Thirty-four per cent of mortgage holders have a HELOC, according to the Canadian Association of Accredited Mortgage Professionals.

"Over the last decade, lines of credit have replaced emergency funds in the Canadian economy," says John Parker, a president of Tudor Mortgage Corporation.

Mr. Parker, a 32-year mortgage industry veteran, says most people with credit lines would rather use their personal savings to pay down the principal of their mortgage than earn a skimpy 1 to 2 per cent in interest.

For thousands of homeowners, this makes perfect sense. Mortgage prepayments provide a better after-tax return than virtually any savings account, and low rates make emergency borrowing from a HELOC less costly. Funneling savings into your mortgage is even more appealing if your mortgage has a built-in (a.k.a. readvanceable) credit line that lets you reborrow those funds in urgent situations.

The growth in HELOCs – up roughly 170 per cent since 2001 – is the chief reason why so many mortgage holders don't have emergency funds. But HELOCs don't work for everyone. You need a down payment of 20 per cent or more to get one, and one out of five homeowners don't have that kind of equity. (An unsecured credit line may be an alternative for some people.) You also need the fiscal discipline not to blow your credit line on impulse purchases.

If you don't have 20-per-cent-plus equity, options become more limited. Conventional wisdom holds that someone with minimal equity and no emergency funds should save at least three to four months of living expenses before going shopping for a home.

On the other hand, a large war chest of savings is somewhat less critical for qualified borrowers with strong stable jobs, low debt-to-income, and/or mortgage payments that are comparable to what they'd pay in rent.

In the end, the decision to buy now or save more depends on your circumstances, as it always does.

If your finances do need reinforcing, don't lament about being stuck on the real estate sidelines while you accumulate cash. In most parts of Canada, there is no urgency to buy.

"The risk of being priced out of the market is less than it's been in a long time," Mr. Parker says. "In most places, prices are unlikely to increase by any significant number for the next few years."

That's a realistic prediction that virtually every housing analyst on Bay Street would agree with.

Robert McLister is the editor of and a mortgage planner at Mortgage Architects. You can also follow him on twitter at @CdnMortgageNews.

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