Mortgages: How Big is Too Big?

mortgages-how-big-too-bigIs it possible to have a mortgage that is simply too large? Here is the conventional wisdom:

Buy as big a house as you can afford, because long-term house prices always go up, so you can’t lose.


It’s okay to take out a bigger mortgage to increase your leverage, and because interest rates are low, it will be fine because it’s “free money”.

The conventional wisdom is partially correct.  Over a long period, 10 or 20 years, house prices historically have increased.  However, there are many examples of house prices dropping and not recovering for five years. If your time frame is short there is no guarantee you will make money on a real estate investment. After factoring in the additional costs of realtor fees, property taxes and land transfer taxes, you may end up losing money. Mortgage rates are low now, but interest rates historically go up and down, so there is no guarantee that you will always have an attractive and affordable mortgage interest rate.

That’s why I believe that yes, it is possible to have a mortgage that is too large for you in your unique circumstances.  If house prices soften, or if interest rates increase, or both, you could be left with more mortgage debt than you can handle. In fact, CMHC now implements a stress test on high ratio loans to prevent people from signing on for more than they can afford.

How Much Mortgage SHOULD You Carry?

So how big is too big?  How can you tell if you have more mortgage than you can handle?  There are two factors to look at:

1. Is your monthly payment affordable? There are a lot of percentages out there but in truth how much you can afford depends on your lifestyle. If you want to go out a lot, you can’t afford to overextend yourself with mortgage payments. If you live a frugal lifestyle and your desire is to own a larger home, you might be able to keep up with larger payments.

Here’s the thing. No matter how much you hate it, you have to run some numbers. Create a budget, even just this once, before you buy a home or take on a second mortgage.

If you struggle to make your mortgage payment each month (and your property taxes, condo fees, and other expenses), your mortgage is too big.

2. How much equity do you have in your house?  Equity is the cash you would get if you sold your house.

To calculate your equity, take the estimated selling price of your house and subtract the mortgage balance and selling costs (real estate commissions, legal fees, and any penalties to break your mortgage).  The difference is your equity. Are you in the red?

Your down payment is NOT equity. You have to resell your home to realize any equity. Buy a home today and you still have selling costs to liquidate tomorrow. Also any down payment raised through other debt doesn’t mean you have equity in your home since you ultimately have to pay off this debt too, secured or not.

So what equity is a safe number?

Obviously the more equity you have the better.  We reviewed all of the data from everyone who has recently filed a bankruptcy or consumer proposal in my firm’s Joe Debtor study. We found that 29% of people who file a bankruptcy or consumer proposal own a home. So owning a home is not a cushion against bankruptcy. In fact, the size of your mortgage can be an added risk factor.

The average consumer proposal filer had a mortgage equal to 91% of the appraised value of their home.  In other words, if they sold their home, they would only have 9% of the value of the home to pay real estate commissions and other selling costs.  That’s not much equity.  Worse, 56% of proposal filers had a net realizable value of zero or less.  They had no equity.  The remaining 44% of people had an average equity of $14,126.

That’s not much equity.

For bankruptcy filers the numbers are even lower, with average mortgages equal to 95% of the value of the house, so if they sold their house they would only have 5% of the house value to cover selling costs.  With real estate commissions at 5% it’s obvious that there’s not much equity in those homes.  In fact, 87% of bankrupts had no equity at all.

So what’s the level of mortgage that is “too big”?

If your mortgage amounts to 90% or more of the value of your house, based on our numbers, you are at serious risk of having debt problems that may require you to file a bankruptcy or a consumer proposal.

What is the reason for this? You have no margin for error.

With only 10% house equity you may not be able to sell your house and cover your selling costs and “get out even”.

I recommend that you crunch the numbers on your mortgage to determine if you are at risk, and if you are take steps to pay down your mortgage faster, or consider selling your house and moving to less expensive accommodation if possible.

If in addition to your mortgage you have other debts, it may be wise to contact a debt expert like a Licensed Insolvency Trustee so they can give you some advice on how to deal with all of your debts, including your mortgage.

Category: Debt Management | Tagged in:

May 10, 2017


About J. Douglas Hoyes

J. Douglas Hoyes, BA, CA, CPA, CBV, CIRP is a Licensed Insolvency Trustee and the co-founder of Hoyes, Michalos & Associates Inc., one of Canada's largest independent personal insolvency firms. As an expert in debt management, Doug has been helping people deal with debt for more than 20 years.

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