In case you were wondering why the markets have declined by almost 5% this week to build to a 3-week loss of over 10%, we give you this local example of the wide-spread problems that are expanding into non-sub-prime territory in the US:
Reflections is having trouble pre-selling its units. Until it gets 65% of the building sold, bankers won't lend them the construction seed money to finish the project. It sat for the better part of a year with little to no work being done while salespeople worked in overdrive. It quickly became apparent that something creative needed to be done.
Enter Canada's version of the Alternative Rate Mortgage. The developers at Reflections are offering you a teaser rate. Now they don't have any control over the actual interest rates you'll be charged by your bank. But they do have control over how much you will have to pay in total. The monthly payment on a $340K condo is roughly $1800/month (40-year amortization, 6% interest, 0% down). Developer drops the price by $10K, and your monthly payment is still unattractive. So what are they going to do?
How about tease you with cheap mortgage payments for a year? Which is exactly what they have done. You pay them full price ($344K or $334, depending if you read or heard the add) and they give you a cash-back option equal to half your mortgage payments for one year (12 x $900 or so). At last count, they had 10 units for sale under this scheme and 3 units sold leaving another 7 to go.
Now I know some of you are going to claim this isn't sub-prime. And your right. The lender will still need to qualify the buyers and the buyers will still be required to purchase mortgage insurance. But what this has done is artificially inflate the purchase price of the condo. How can I say this? Because they'd have no trouble selling the units if they dropped the price down to what consumers are willing to spend.
Just how big is this problem? In the Victoria market it's--as far as I know--contained to Reflections. But think how wide-spread this credit issue is throughout our economy. Bought a car recently? Did you get 0% or 7% financing? My guess is you got much lower than 7% if you financed through the dealer's creditors. Bought furniture? Did you "buy now and do not pay for one full year?" How about electronics?
You may have noticed that prices in these categories aren't really inflated, but the demand has been. This is why I argue vehemently that true inflation numbers are much higher than the CPI suggests. Demand has been inflated too. And when people borrow to spend now it creates long-term economic consequences in much the same way that increased prices do.
It's these types of new-fangled credit schemes, targeting those that don't qualify for traditional credit products, that have created the largest credit bubble in world history. In the US it seeped into over 20% of the housing market. Up here in Canada, experts are claiming it's only 5% of our housing market. But the problem is so much bigger than the so-called sub-prime debtors because many so-called "prime" candidates--you know, people with good credit--have taken advantage of loose lending so that they can over extend themselves too.
When assets start to decline and the real interest rates start to kick in, those "prime" buyers look twice at their debts and usually stop spending. They want to consolidate into the cheapest interest bearing vehicle (the HELOC) but their home's value has dropped and they can't get one. They either walk away or get forced out of their assets (homes) because lenders need to get something for the debts they are owed. And good creditors become "victims" of their own desires to have everything now and lenders/retailers desires to provide everything now for a price that won't drive you out of your home. Oh, the irony.
If I had a nickel for every teaser interest rate pre-approved credit card I've been offered by mail or over the phone I wouldn't need to work. Guess what? I haven't worked much over the past 4 years while I've been in university. Don't you think I shouldn't be offered pre-approved 0%-for-the-first-year credit cards with limits totaling 25% of my yearly gross income? I do. So I say no. I bet I'm in the minority on that one though.
Painful economic times are coming. And they are deserved.