Message from the Broker, Andrew Zsolt
A new study warns that one in 10 homeowners younger than 40 would be in significant trouble with their mortgages if the housing market were to crash. The study continues to state that Canada’s hot housing market is putting young homeowners at significant financial risk.
If home prices dropped 20%, nearly 260,000 Canadians would see their net worth wiped out, states the study completed by the Canadian Centre for Policy Alternatives. This drop in prices represents the midpoint in the Bank of Canada’s estimates, which asserts that Canadian home prices are overvalued by anywhere from 10 to 30%.
Young Buyers Should Be Cautious
The study’s author, economist David Macdonald, writes that although a price drop of 20% may be larger than most bank economists are predicting, it would be wise for young Canadian homeowners to take precautions.
Adults in the 20s and 30s have, in recent years, gone into the deepest debt in order to buy a home. A major real estate crash would see significant numbers of this age group pushed underwater, where they owe more than they have in assets.
Canadians in their 30s have begun to carry debt worth an average of four times their income. According to Macdonald, their debt-to-income ratio is the highest in any age group, and has risen the fastest. Due to their money being tied up in mortgages, if the housing market were to crash by only 10%, young Canadians would see 20% of their net worth wiped out, while a 20% market crash would destroy 40% of young Canadians’ net worth.
This number rises only exponentially, based on the percentage of a market crash. A price drop of 30% would wipe out 61% of the net worth of young homeowners. “The most at-risk families are those who are heavily leveraged, with all their wealth in their house and who arrived late to the real estate party,” Macdonald states.
Large Cities Could See The Biggest Impact
The situation would only be dramatically worse in high-cost cities like Toronto, Vancouver, and Calgary, where young Canadians take on the highest priced mortgages in the country.
Middle-aged homeowners in their 40s, 50s, and 60s, stand to lose the most money - on average $70,000 to $80,000, since these individuals usually own the most expensive homes. But this only represents an average of 21% of their net worth, given that older Canadians tend to have more equity, less debt, and have less of their net worth tied up in real estate, compared to young homeowners. Those in the 60s and 70s would only see a drop of 10% in their net worth.
“We need to recognize that young families are the most likely group to be plunged underwater by a nasty housing correction,” Macdonald says to The Globe and Mail. “There is still time to plan for that tidal wave.” He stresses that governments must help prioritize helping Canadians reduce their high levels of household debt in order to protect young families from mortgage prices which will eventually rise.
In the United States, federal programs were introduced after the 2008 housing downturn, which gave unemployed homeowners the option to stop paying their mortgage for up to 12 months while they looked for a new job. In that situation, a program was introduced which reduced the principal on the mortgages of struggling homeowners to reflect the new, lower values of their homes.
Macdonald writes that a similar program could be used to bail out Canadians in the same situation, although it would ultimately require a buy-in from Canada Mortgage and Housing Corporation, in order to be successful.