Why you should beef up that down payment fund first

A few years ago you could get yourself a CMHC-insured mortgage with no down payment or a 40 year amortization. But if you go back a few decades, the norm was to put 20 per cent down with a 25-year amortization. And when you factor in today's ultra-low interest rate environment, you've got two major reasons as to why houses are so expensive. Credit is easy and plentiful.

For the same reason that someone earning $60,000 a year after tax will find a way to spend $60,000 a year, if you give someone a $400,000 mortgage they'll find a $420,000 house (with the minimum 5-per-cent down payment). Many people have a tendency to live precisely at their means, as opposed to within their means.

If you look at metrics like the ratio of house price to personal disposable income, the national average in 1980 was around eight. It increased to just under 10 by the late eighties and early nineties when we saw some real estate downturns, but by the beginning of 2011 had increased to over 12.

Essentially this is saying house prices have grown much faster than incomes. And yes, it is very much exacerbated in Vancouver, where that ratio breached 25 in early 2011. The ratio has been high in other markets, too, breaking through 15 in Toronto.

With the spectre of higher interest rates in the offing, the maximum mortgage amounts people will be able to carry will decrease. Add in heightened regulatory oversight and a decrease in the ability of CMHC to insure high-ratio mortgages with the volumes it has been for the last five years, and the headwinds on credit are significant.

A continual rise in house prices while incomes stagnate is not sustainable. We all know that eventually something has to give. Either incomes have to shoot up (unlikely over the short term) to continue supporting the price increases, or house prices have to fall. The third alternative is a period of protracted stagnation in house prices as incomes slowly increase. People talk about the "lost decades" of stock returns; that scenario could easily play out in real estate.

If you are looking to buy your first house, I would recommend waiting and keep adding to your savings instead, aiming for a 20 per cent down payment. If that sounds crazy, it's because house prices are too high or your income can't support the house you've been dreaming of. If there is a real estate correction, then your down payment will get turbocharged. If there is no real estate correction, then at least you'll be on much firmer financial footing by the time you're ready to buy.

Preet Banerjee, B.Sc, FMA, DMS, FCSI, is a W Network Money Expert, and blogs at wheredoesallmymoneygo.com. You can also follow him on twitter at @PreetBanerjee