By Frank Kirschner
U.S. President George Bush recently announced a stop-gap (albeit limited) measure that may assist many U.S. homeowners from experiencing what millions already have – losing their homes. In light of the dilemma south of the border, what can we Canadians learn from all this, and how can we be better prepared to avoid similar devastating effects?
A brief history of U.S. home lending practices: it all started when credit was provided early in the 20th century after the Great Depression. Lenders first offered simple interest 80/20 short-term loans; 80 per cent down and 20 per cent financing. Then some ingenious private entrepreneurs and banks decided they could charge more interest by providing 50/50 loans over longer periods. They saw the opportunity to really make large returns on their investments. 50/50 soon became 80/20, with 20 per cent down and 80 per cent financed. After lobbyists pressed Congress, they eventually passed a law approving compound interest, not long after the Second World War when all the vets returned home.
Amortization schedules and pay-off times went from five and 10 years to 15, 20, 25, 30, 40 years and more. The banks capitalized enormously on these lending practices. Compound interest extended for as long as the gullible public would bear, and made the banks astronomically profitable. Initially they weren’t even sure if they could convince the general public to contract such huge long-term debt commitments. But untethered capitalism and the desire for “more than one could really afford” reigned supreme. Communities like Levittown (America’s first planned “assembly-line” subdivision in Long Island, N.Y.) were enormously successful. The groundwork for today’s real estate and mortgage template was cast.
People who really couldn’t afford the credit they desired were given loans at higher rates to counter balance higher gross-debt-ratios. Even those who didn’t qualify under normal circumstance could also live beyond their means through creative and exotic loans like
Adjustable Rate Mortgages (ARMs) and 40- or 50-year amortization periods. Therein lies the core-formula for millions of Americans losing what used to be their most valued and protected asset, their homes. The formula was to over-extend ourselves, live beyond our means or buy more than we could really afford, with funding provided by a lending system that understood high-risk, high-return and gladly participated. Lenders became ‘enablers’ for a public who acted like dope-crazed addicts, never able to satisfy their need for more of this euphoric drug – extended credit.
As long as equity in their investments continued to grow, they were safe. But when over-inflated house values soon began to deflate, they could no longer tap into the reservoir of ‘savings’ built into their homes.
After extending themselves even further with home equity loans, thus adding another monthly payment, the American public was trapped. They became unable and/or unwilling to continue to pay for homes that were worth less than what they owed on them, especially if it crimped their salacious appetite for a lifestyle they could no longer afford. The fallout became apparent to the lending institutions and they quickly lobbied Congress to make it harder for people to bail out through bankruptcy. To nobody’s surprise, the law was passed.
To date, Canada and Canadians have been spared, for the most part from the major fallout experienced in the U.S. Why? We have yet to lower our standards to the point of our neighbours to the south. But will we continue to hold higher standards – and for how long?
That’s the key.
So as a dual citizen who has lived and worked for equal years in the U.S. and Canada, I say, take heed. Be cautious. Real estate, though cyclical, is being influenced by new parameters that have to be weighed in the balance – including demographics and preferences of aging baby boomers, the economic impact of ever-increasing oil prices and the like. How can we protect ourselves? We can try to avoid extended amortization periods, exotic loans and creative financing; but most importantly, simply live within our means – an unpopular idea, but the undeniable truth.