Mortgage Mayhem

Millennials are frequently blamed for the downfall of businesses and even entire industries. These include department stores, cereal, and diamonds just to name a few. Heck, some believe we will be the downfall of society as a whole. The accusations sound exaggerated and even humorous but the reality is; we’re not spending money on a lot of the things that our parents spent money on.

I’d like to think the reason is that the world is a lot more financially hostile than it was 30 years ago. Think of it this way; back then, someone working a blue collar job in a factory could earn enough to support a family and buy a home. There’s no way that’s happening now.

And recent developments aren’t helping. The Office of the Superintendent of Financial Institutions (OSFI) is the Canadian regulator for banks, and on October 17, 2017, they updated one of their guidelines. Guideline B-20 − Residential Mortgage Underwriting Practices and Procedures outlines the procedures and practices each bank should follow in order to approve and extend residential mortgages to the general public – people like you and me.

The major change involves increased stringency in stress testing. For each mortgage application, as part of their risk approval process must run a stress test involving different scenarios to assess whether the borrower can repay their mortgage under various circumstances. One of these is the increase in interest rate. Interest is a percentage of the total value of your mortgage and is repaid along with the principal borrowed amount. As interest rates rise, the value of each payment made at every interval increases.

The change in the guideline requires uninsured mortgage borrowers to show that they can afford to pay for a mortgage at a rate that is 2% higher than the rate that they are applying for in order to get approval. These borrowers are those that have made a 20% downpayment and are not required to get mortgage insurance with the Canadian Mortgage and Housing Corporation (CMHC).  This translates to a substantial decrease in borrowing power.

To illustrate, let’s assume that you have enough income to spend $2,000 of your monthly income on mortgage payments. The rate that you are applying for is a 25-year term with a 2.45% fixed interest rate. Based on these numbers, theoretically the maximum mortgage you could obtain is around $440,000. With the new rules, you have to add a stress test of 2% to the 2.45% that you are applying for. If you apply the same formula at 4.45%, the maximum mortgage you could obtain drops to around $350,000. This gap widens as the value of your loan increases. If you could originally afford a $1,100,000 mortgage, you would only get a $900,000 mortgage.

The reason for this change was mainly to protect the housing market from shock in case of additional interest rate hikes. Nevertheless, the change adds further financial pressures on millennials and any new families looking to buy a home. With finances tight and the future uncertain, it’s even more important to know what financial resources you have and how to use them.

Millennial Relevancy

Financial literacy was only recognized as an issue recently; for most, it didn’t feel relevant nor did they have any interest. Most articles calling for more financial education only surfaced around 2013-2014. The rising need for financial literacy in the general public, in my view, is due to two main factors.

The cost of living is increasing, and wages are not keeping up. Statistics Canada tracks the Consumer Price Index of Canada on a monthly basis. The purpose of this index is to indicate how much the cost of living has increased from a reference year to the current point in time. According to their data, the CPI has increased to 130.4 in July 2017 from the 100 reference point in 2002. It has increased by over 30% in 15 years! In another study, Statistics Canada has indicated that between the years 2000 and 2013, the average increase in income was 1.2% annually. When calculated, that’s an average income increase of only 19.6% in 15 years! I understand that the statistics may not be perfectly comparable. However, the bottom line is, we are spending more but earning less as time progresses.

The other reason for the urgency to be more financially literate is the increase in Financial Technologies (FinTech). There are more ways than ever to connect to your finances. This includes phone apps for banking, online self-directed stock brokerage (Questrade), robo-investor (Wealthsimple), primary bond issuance platform (Overbond), pay-per-mile car insurance (Metromile), real estate investment platform (Cadre) just to name a few. These services are delivered to your fingertips at the touch of a button (or screen). Companies are spending millions if not billions of dollars on new technologies to better their financial services, and to market their services. These technologies are rapidly integrating what was once the exclusive territory of “business people” into the lives of every person on the street.

Suddenly, in a world where budgets, money, banking, investing are discussed everywhere, governments realize that most of their population have no idea what is going on. If you search “Financial Literacy” on any search engine, you will see articles of panicked governments frantically trying to address the problem. They are going to great lengths to ensure the future of their population is financially literate. In fact, the Ontario government is now piloting the integration of financial literacy into their school curriculum.

The unfortunate part of this story is, there is an entire generation who did not benefit from government or school board training who are just beginning to enter the workforce. That is us; Millennials. While, for previous generations, this is also an important issue, the greatest impact is on Millennials. We have our entire professional lives and careers ahead of us and in about 10 years, we will have to compete with our younger counterparts who will have Financial Literacy training.

Becoming financially literate is no longer a matter of interest, but a matter of relevancy and to some degree, survival.

Millennial Paradox

A study by the Bank of America Merrill Edge gives some interesting perspectives as to how millennials think and what we do with our money. Yes, I’m a millennial.

The report states that 63% of millennials “are looking to save a set amount of money or income necessary to enjoy their desired lifestyle.” The report goes further to state that millennials are 81% more likely than their older counterparts to spend money on travel, 65% more likely to spend on dining and 55% more likely to spend on fitness. From this, it looks like we are more interested in saving and spending on shorter-term goals versus long-term goals like retirement.

What I find fascinating about this report is that the majority, or 63%, want to have enough money to live their ideal lifestyle. I suppose for each person this lifestyle is different but it’s interesting how a comfortable retirement doesn’t seem to be a top priority; instead, the focus is the next getaway to a faraway land.

The main issue I see with this mentality is, practicality; how are we going to retire with no savings? Had we had enough savings, we could enjoy our retirement and travel later in life with the money we had saved. If we don’t have savings, we may be working a part-time job at the age of 65.

I’d like to think of this as the millennial paradox. If our ultimate goal is to have the money to live the lifestyle we want, why are we not pursuing that in the long run? Ultimately, without savings, in the long run, this “lifestyle” for the vast majority of individuals will not be sustainable.

I think one of the main issues is we believe that we don’t earn enough to save. Really, that’s an inaccurate assumption. Even $20 out of each of our paychecks is better than nothing. That’s about $1 a day and less than the cost of a coffee. This $20 doesn’t just stay at $20 in value. Assuming we put in something that earns us interest, it will grow. The $20 will earn interest and the interest will earn interest for the next 30 years until retirement. If we could save more, the growth potential increases exponentially.

Another issue is that we just don’t care. I say; wake up! Aging is inevitable, one day we will want a break. The question is, will our finances allow us to take that break?