Economic Forecasts could fry your mind

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Garth Turner and Dean Baker of the Wastington based Centre for Economic and Policy Research both have said that residential real estate values are ready to plunge by 25%.  The Bank of Canada Governor Mark Carney has cautioned that mortgage debt at the current low interest rates are not sustainable.

So, what can you do about that?   Well, economists can create some exciting headlines with selective data, so I am rather glad they are not our weather forecasters.  Sometimes data can be manipulated to present a shocker of a news story.

How?  Take the weather change of Calgary from January 15 to February 4th.  There was a 35 increased degree change.  Forecasting to July 1- there will be no Canada Day celebrations and you really don't have to be worried about any mortgage debt.  At a forecast temperature of over 200 degrees Celsius- you will be fried!   No worries!

As part of Baker's argument, he shows a current 35 year amortized mortgage payment and says if rates go up by 2 percent, that will result in a 25% decrease in mortgage.  So, today five year fixed rates are about 4%, so that makes it a 6% rate.

What are the numbers?    Today's mortgage payment on a $400,000 mortgage is $1763.21 per month.   Assuming no extra payments are made, your mortgage balance in five years will be $370,796.21.   You have to renew for the remaining amortization of 30 years.   And, what are the payments at 6%?  $2205.59.     That's $442.38 more per month.

Baker has used the assumption that you barely qualified to buy your home.  In five years, he assumes you (or any person who may want to buy your home five years from now) can still only afford a $1763.21 payment.

WHY DO RATES EXPECT TO GO UP?   Fixed term rates are generally linked to Bond rates, and that is borrowings by governments and corporations.  Bond investors want a rate of return over inflation and to compensate for risk.  They tend to anticipate what inflation rates will do in the future.   The Bank of Canada has a mandate to curb inflation pressures and does so by raising it's rate it charges to lend to banks.  That's were the variable rates for mortgages are affected.

Inflation.   Inflation caused by economic activity.  Economic activity that puts pressure on production costs.  Production costs include labour.   Labour cost increases tends to reflect in your pay, too.   Do you expect NO RAISE if the economy is doing well?  Hmmm.

Let's say you are one of the unfortunates that is not going to see an increase of income these coming years.

IF that is true, a 6% mortgage amortized over 30 years with the same payment you have today can only be $296,425.79.    Yes, that is a plunge of 25% from today.

But, just as the Calgary forecast can be tricky if you only use one point of reference, there is a way to avoid being burned.

Most credit cards have about a 3% monthly minimum payment.  To reduce your payment by the $442.38 mortgage payment, pay down your credit card by $15,000.    That's $3,000 per year.    If you qualfied at generally accepted 35% of pre tax income for housing costs, you would have household income now of about $75,000 per year.   So, use 4% of your  income to reduce your credit card debt.

Or, using the same qualifying standard of 35% of income, you need to increase your income in five years by a little over $15,000.   That's a household income increase of $3,000 per year.    So, work to increase your household income about 4% a year.

OR, any combination of the two can be used to mitigate the effects of rising rates.