I recently finished a book by Jeff Rubin – “Why your World is About to get a Whole Lot smaller” – it was an interesting book and highly recommendable. I understand this is one individual’s opinion on what the extreme prices of Oil can do to our society and our economy but I looked at the specific role that Oil would have on the Canadian Real Estate market.
In summary, Mr. Rubin stated:
- Soaring oil prices have caused four of the last five global recessions
- Oil prices brought down the global economy, not the subprime mortgage
- Inflation triggered by high oil prices started to increase the cost of debt
- Household debt has risen in US, UK and Canada by over 20 percentage points – this was okay when low
interest rates and easy credit was available but now the repercussions are being felt worldwide
- With high oil prices, money is being transferred out of oil-importing countries to oil-exporting countries – where savings are at 50%
- Central bankers will tell you that your borrowing rate is a mirror image of the inflation rate, if inflation is 5% and I lend you $100, then you will have to pay me $105 back
- The higher the interest rates, the fewer the amount of people that qualify for loans
- Interest rates and inflation were low because of cheap energy which means little inflation
- Low interest rates come from low inflation and low inflation comes from globalization which brought down interest rates and thus boosted purchasing power
- Under cheap oil over the past three decades, inflation shrank from double-digit rates to as low as 1% in North America and interest rates followed suit – these record low interest rates brought easy credit conditions
- The easy credit conditions meant that as a borrower you could buy your house with minimal down payment
- Soaring energy costs drove the overall consumer price inflation rate from below 2% to almost 6% during the summer of 2008, reaching its highest mark since the 1991 oil shock
- As rising interest rates started catching up with inflation, a mountain of sub-prime mortgages came due for refinancing, which was now double and this started the unravelling in the market
- If oil prices had stayed at $20-$30 per barrel, inflation would not have risen and neither would have interest rates
Unless I see another reason behind the root cause to the past recession, I do believe that the rise of Oil prices was the root problem.
I personally think that once the tide goes out and interest rates do go up we will discover who has been swimming naked.
How do you mitigate the fact that mortgage rates will inevitably move up? A few strategies that I use are:
- if you have a variable mortgage rate, increase your monthly payments to the 5 year fixed posted rate – this will help avoid a payment shock when your mortgage rates go up and it will also accelerate your debt reduction as you will be paying more of your principal mortgage
- convert to a fixed mortgage rate. If you choose this option, now is the time to do this as Bank of Canada is expected to increase rates shortly.
The goal is to always break even on a monthly basis after paying the mortgage, property taxes etc.
The important point is to focus on surviving the downturns to reap the benefits of the long term upturns which is why I look to hold a property for at least 3-5 years before considering selling it into the market.
