Have you ever seen national home prices run up so far so fast?
Neither has anyone else.
This logarithmic chart below shows percentage changes in average Canadian home prices over time. The last 12 months have been unlike anything in modern records. The closest such price eruption was 1989, after which home values needed a decade-long breather.
Valuations clearly have regulators worried. The Bank of Canada, for example, has been warning of “extrapolative” expectations. In other words, a record number of people seem to think recent price gains are an indicator that prices will keep inflating at an unsustainable pace.
How reliable are public expectations? After huge price moves, the answer is not very.
Research finds that “year-ahead home price expectations are revised in a way consistent with short-term momentum in home price growth.” And short-term momentum eventually ends. In fact, as we saw last May and in 2017, it can end fast.
As we write this, there are early signs that price pressures in some markets (e.g., the GTA) could start abating in the coming months, as this chart from HouseSigma suggests.
Source: HouseSigma (partial month data)
And let's not forget the record 335,000 housing starts in March and 0.5%-point increase in fixed mortgage rates. Both are slightly bearish for home prices, other things equal.
Rates are based on a $300,000 mortgage.
The Time for Leverage May Not Be Now
What does any of this have to do with mortgages?
One worry is young people buying too much house with too little equity. Average new mortgage amounts are surging. If you’re seeking financing with only a 5% down payment, particularly if your debt ratios are above-average, tread carefully. A high-ratio purchase today risks years of being underwater on a mortgage if home prices revert to their mean—as they always do—sooner than expected.
Price weakness could effectively trap you in your home if you didn’t have other financial resources to pay off the mortgage and transaction costs.
By no means is that a crash prediction, however. For all we know, prices could surge another 20% from here. After all, housing inventories are still too low, fiscal stimulus is out of control and we are in the expansionary part of the business cycle. That’s generally a recipe for strong employment and home appreciation.
But when you buy with 99% financing on day one (including default insurance fees), it doesn’t take much correction to leave you holding negative equity. A minor 10% price dip three years from now, even after years of making principal payments on your mortgage, could keep you from selling and covering all costs if you didn’t have other liquidity.
5%-down mortgages are made for people who know they’ll be in a much stronger financial position in a few years. If your future earning potential isn’t bright enough to wear shades, you probably should steer clear of low-equity mortgages…unless you don’t mind being bound to your home long-term.