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The situation is worse in high-cost cities, such as Vancouver, where young homeowners are taking on the largest mortgages, the study says.Darryl Dyck/The Globe and Mail

One in 10 homeowners younger than 40 would be underwater on their mortgages if real estate prices crashed, according to a new study that warns the country's red-hot housing market is disproportionately putting young Canadians at financial risk.

Nearly 260,000 Canadians would see their net worth wiped out if home prices dropped 20 per cent, the study by the Canadian Centre for Policy Alternatives found. The drop in prices is larger than most bank economists are predicting, but it represents the midpoint in the Bank of Canada's estimates that the country's home prices are overvalued by anywhere from 10 to 30 per cent, the study's author, economist David Macdonald, writes.

Of those homeowners pushed underwater by a major real estate crash – owing more than they have in assets – more than half would be in their 20s and 30s, the age group that has gone the deepest into debt to buy a home.

Canadians in their 30s carry debt worth an average of four times their incomes. Their debt-to-income ratio is the highest, and has risen the fastest, of any age group, Mr. Macdonald writes. Thanks to the fact that they are highly leveraged, young Canadians would see 20 per cent of their net worth wiped out for every 10-per-cent drop in home prices, so that a 20-per-cent price drop would destroy 40 per cent of their net worth.

A price drop of 30 per cent, meanwhile, would wipe out 61 per cent of the net worth of the youngest 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," he notes.

The situation would be "dramatically worse" in high-cost cities like Toronto, Vancouver and Calgary, where young homeowners are taking on the largest mortgages, the study says.

Middle-aged homeowners in their 40s, 50s and 60s would stand to lose the most money. Mr. Macdonald estimates they will lose an average of $70,000 to $80,000, as a result of owning more expensive homes. But that would only represent 23 per cent of their net worth, given that older Canadians tend to have more equity and less debt, and have less of their net worth tied up in real estate than younger homeowners. For those in their 60s and 70s, a 20-per-cent fall in prices would mean a drop of only 10 per cent of their net worth.

Governments must prioritize helping Canadians reduce their high levels of household debt if they hope to protect young families from the devastating effects of falling home prices when mortgage rates eventually begin to rise, Mr. Macdonald writes. "We need to recognize that young families are the most likely group to be plunged underwater by a nasty housing correction," he says. "There is still time to plan for that tidal wave."

Federal programs introduced in the United States after the 2008 housing downturn gave unemployed homeowners the option to stop paying their mortgage for up to 12 months while they looked for a new job. Others programs allowed homeowners who were deeply underwater on their mortgages to walk away from their home with less of a hit to their credit score than a foreclosure.

A program that reduced the principal on the mortgages of struggling homeowners to reflect the new, lower value of their homes could be used to bail out Canadians in the same situation, Mr. Macdonald writes.

The U.S. Federal Housing Administration's Refinance for Borrowers with Negative Equity program flopped south of the border in the face of resistance from mortgage insurance companies – only 4,600 out of a million eligible homeowners ultimately qualified. Such a program could benefit young homeowners here, but it would likely need buy-in from Canada Mortgage and Housing Corp. to be successful, Mr. Macdonald says.

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