06/15/2016 10:49 EDT | Updated 06/16/2017 05:12 EDT

Don't Let Real Estate FOMO Set You Up For An Ugly Bankruptcy

Shutterstock / Olivier Le Queinec

It's called FOMO; the Fear Of Missing Out. It's the number one reason you think you have to buy a home right now. And guess what: the real estate agents know it. They talk about building equity, and tell you about clients who sold at prices way above asking, with competing offers, and with selling prices several times their original investment.

Those stories may be true, but let me give you a different perspective. In 2015, 121,609 people in Canada declared personal insolvency. Based on the profile of the average insolvent person, 24 per cent of all insolvencies we performed were for people who owned a home at the time they claimed bankruptcy or filed a consumer proposal. So, as the headline suggests, that means that 29,186 homeowners (give or take a few) declared insolvency in 2015.

And this was at a time when home prices across Canada rose 8.5 per cent, Canada's unemployment rate remained stable at 6.9 per cent and interest rates were at a historical low.

Real estate agents can talk about the upside of buying right now, but they don't explain the downside of carrying massive debt. Yes, you may build some equity if you purchase a home, but if you've mortgaged 90 per cent of it, very little of your payments in your first five to 10 years will go towards repaying principal.

Yet, during this time, you will have other financial pressures: houses need repairs, property taxes go up and children come along. The economy can (and will) turn on a dime, threatening your job. Illnesses happen. I see many clients who, because of these uncontrollable events, find themselves not only heavily mortgaged, but deep in credit card debt as well.

You could find yourself in a similar situation and any appreciation in your home value would be used up by a second mortgage to pay off credit card debt. You would be back to square one.

I'd like you to consider recent data from the Bank of Canada that clearly shows risk levels for homeowners are increasing:

  • Mortgage debt now accounts for 65.6 per cent of all consumer credit. That is a significant amount of debt that is subject to potential interest rate shocks. Rates may be low now, and may remain low for the near future, but will they remain low until your next renewal date?
  • Roughly 15 per cent of new mortgages issued in 2015 had a loan-to-income ratio of more than 450 per cent, up from 12 per cent a year ago. High ratio mortgages are a key driver of insolvencies based on our own client study.
  • Almost half (46 per cent) of all uninsured mortgages have amortization periods greater than 25 years, up from 42 per cent. Worse, 58 per cent of new uninsured mortgages issued in 2015 had an amortization period of longer than 25 years. In other words, record low interest rates are not enough to make mortgage payments affordable at these inflated housing prices. Homeowners are increasingly relying on 30- and 35-year amortization periods to make payments work.

So, if roughly 29,000 homeowners declared insolvency in 2015 -- what will the numbers be when the economy weakens? Boom times don't last forever.

A home is not an investment and buying one purely as an investment is risky. Are you willing to sell when you think the market has reached its peak (assuming you don't think it's there already)? Will you be able to afford the carrying costs for the long term? When you buy a mutual fund, one of the disclaimers is that past performance does not guarantee future results. The housing market is no different. Before you buy, you should consider how much personal risk you are willing to take on.

My advice is to calculate how much money you want to spend each month on housing costs. Work backwards from there. What can you rent for that amount? How much can you buy? If you can't buy in at that price, then don't.

Don't let FOMO influence your financial decisions.

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