Will 300,000 Canadians soon have more debt than assets?

This week, the Canadian Centre for Policy Alternatives released a study by senior economist David Macdonald that says a home price decline of 20% would leave 169,000 families under 40 in a negative-equity position, with more debt than assets.

“Declines in real estate prices would have a strongly disproportional impact on young homeowners,” according to Macdonald’s report. The average debt:income ratio among 30-somethings has hit 4:1, almost double what it was in 1999.

20% is an awful lot, and the pundits are still arguing over whether we’ll see a decline at all, let alone a bad bump like that. Still, the report warns that a 30% decline (which seems completely unrealistic) would see one in seven young families, or nearly 300,000, under water.

Even with wider asset diversification and lower debt levels, middle-agers in their 40s through 60s would see their net worth fall by an average of $70,000 to $80,000, or nearly a quarter. It warns that those in overly hot markets like Toronto and Vancouver stand to see even more dramatic losses than the national average.

The biggest precipitators of such a price fall are higher mortgage rates and lower incomes primarily due to unemployment, the latter of which was the major factor in the U.S. crisis of nearly a decade ago. The report suggests that in the event of such price decline, our American cousins enacted some policies that could help here too.

One of the most important was the HARP, or Home Affordable Refinance Program. Generally, when a house’s mortgage exceeds its value, refinancing is impossible and yet the higher monthly payments can make or break some families. Under HARP, those homeowners with mortgages worth more than their homes were able to refinance to get lower rates.

But, we’re already at record low mortgage rates, with no room for cutting. Their Home Affordable Modification Program (HAMP) allowed homeowners to mitigate other factors, such as extending their terms or delaying payment, therefore avoiding imminent foreclosure, which would likely be more helpful in our situation.

In the US, they also enacted a program called the Federal Housing Administration Refinance for Borrowers with Negative Equity program, FHA Short Refi, which allowed those owners who were current on their mortgage payments to reduce the principal to help align it with then-current house values.

Take-up was poor, as most of the largest mortgage insurers there rejected the program, through which only 4,600 owners out of a million qualifiers could actually take advantage of the program. Here, only the CMHC would need to buy in to help such a program succeed.

Other, smaller programs included an unemployment program that let those suffering a job loss defer payments for up to a year until they found work again. They also had a program that let those with negative equity in their homes walk away from their mortgages with less of a negative effect on their credit scores than without the program.

Bottom line, says the report, is that the deleveraging of the housing sector should be a priority for governments, adding that “there is still time to plan for that tidal wave.”

In their latest report, the Organisation for Economic Co-operation and Development (OECD) echoes that the Canadian housing market may be due for a sharp correction. The OECD is a 50-year-old think tank where 34 democratic governments work together to promote economic growth and sustainable development policies. The report recommends the new federal government step in with tighter mortgage controls, including tightening loan-to-value and debt-servicing ratios.

I’m not an alarmist, and while we may see a downward trend, we’re not likely to see anything close to 20%. In super-hot centres like ours and Vancouver, a big part of the equation is no more complicated than bidding fever, when people decide they simply MUST have a given home at any price, and lose sight of its true value — and often their own financial realities.

Just because a bank will lend you an enormous sum of money doesn’t mean you should use it. We humans can be our own worst enemies.

Whatever the future brings, it’s never a bad idea to start ridding yourself of debt, and despite the recommendations from both recent reports that the government step in, we are responsible for our own choices. If there’s a message here we can really use, for my money, that would be it.