House of cards

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Many homeowners are struggling under the weight of borrowing and borrowing the equity in their home and now they’re left house-poor. (MCT)

The run-up in housing prices over the last decade has been a boon for many homeowners. But for homebuyers, the dramatic price increases have had an obvious downside, especially for first-time buyers.

They've had to come up with larger down payments and obviously they have to carry larger mortgages. Of course, the one thing going in their favour has been low interest rates, even before they hit rock-bottom in 2009.

But for the last several months, there have been rumblings about whether this meteoric rise in prices can continue. And at what point do consumers reach a breaking point in the amount of household debt they can afford to carry?

These are questions that not only apply to first-time buyers, but also to established homeowners who have increasingly taken out second mortgages, capitalizing on the new-found equity in their homes.

Already, many experts have sounded alarm bells Canadians are overleveraged and riding a real estate bubble that has yet to burst.

New York Times columnist and Princeton University economist Paul Krugman recently wrote a blog entitled Uh-Oh Canada, in which he notes Canadians spend and borrow like Americans -- even more so in the last two years as our U.S. counterparts become debt-conscious.

And according to one Canadian economic analyst who publishes a yearly report on the state of Canadian families' finances, our borrowing bubble has already begun to deflate.

"The breaking point happened about two to three years ago," says Roger Sauvé, with People Patterns Consulting in Ontario.

"At least, that's when I started to sound the alarm about the myth of debt -- that we can carry on borrowing without consequences."

Sauvé compiles his annual report for the Montreal-based Vanier Institute of the Family and the 2009 report, issued in February, showed Canadian families' indebtedness has continued to climb, even during the recession when most families focus on saving.

"When I published it, Canadian household debt was 145 per cent of family income," he says about The Current State of Family Finances report. "Today, I think that it would be upwards of 150 per cent."

Sauvé says this trend toward increasing debt loads for families really hit a tipping point starting in 2008. That's when total net-worth assets of Canadian households started dropping.

But the trend really began almost two decades earlier when families stopped saving as income levels stagnated.

"Then in the 2000s, family incomes still weren't terrific," he says. "There was a recession at the beginning of (the decade), so we borrowed and it has been a decade of debt."

Over that time, home prices have grown dramatically, which has helped keep the Canadian families' household-assets numbers relatively robust.

But Sauvé says that increase has had a negative impact on many first-time buyers.

"The MLS (Multiple Listing Service) selling price at the end of October last year was five times household income," he says. "The long-term average is about 3.7 times household income."

In other words, the one thing often tied to the prosperity of middle-class families, ownership of a home, may be making some families house-poor.

But just how does one measure that real estate-induced poverty?

One guideline offered by the Canada Mortgage and Housing Corp. (CMHC) for housing affordability is that combined monthly mortgage, property tax and hydro payments should not exceed 32 per cent of a family's gross monthly income.

But Sauvé says this measurement is somewhat misleading as a starting point because it is based on low interest rates of today.

"The long-term average is something like 7.5 per cent, so if you went from 4.5 per cent to that, and you were paying $1,000 a month in interest, you'd be paying close to $2,000 a month."

Even without rate hikes, some families are already struggling, says financial counsellor Ivy Mannil, with Community Financial Counselling Services (CFCS) in Winnipeg.

She says she has seen an increase in the number of families struggling under the weight of mortgages, quite often second mortgages.

"We're seeing a lot more people who also have second mortgages with non-traditional lenders like CitiFinancial and Wells Fargo, and those carry huge interest rates," she says.

"These people are house-poor -- and even though they're homeowners, they have no equity because they've borrowed and borrowed and borrowed the equity in their home."

While the non-profit uses a similar housing cost measurement to CMHC (35 per cent of net income versus 30 per cent of gross), Mannil says it's only a rough guideline.

"The benchmark is black-and-white, and the reality is that life is not black-and-white," she says.

At the initial consultation, clients are asked to list all of their monthly expenses and quite often it takes a few tries to get an accurate amount.

"A lot of people really aren't good at this," says Mannil, a former loan and collections officer. "We spend a lot of time teaching them how to track their expenses."

And determining whether a home is too costly is beside the point, she says.

"It really comes down to, at the end of the month, what is this person, this couple, this family left with by the time they pay all their fixed expenses?"

Once they have that number, clients have three choices: cut expenses, increase income or, preferably, both.

But it's not the counsellor's job to make those decisions -- though they do have to lay out some cold, hard facts sometimes.

"We're seeing a lot more people with really huge shortfalls, and their debts just are not manageable," she says, adding they may have to consider bankruptcy in those circumstances.

Still, the clients who pass through CFCS's door represent only a small percentage of Manitoba homeowners. It is the front lines of debt problems in the city.

And the vast majority of Manitobans are managing their mortgage and other debts without getting into trouble, says Daryl Harris, Manitoba director of the Canadian Association of Accredited Mortgage Professionals (CAAMP).

"For the most part, Manitoba consumers are very responsible and conservative by nature," says Harris, a broker with Verico One Link Mortgage in Winnipeg. "I don't see a huge amount of people going out and maxing out on their mortgage."

And while home prices have been high, he says house listings have increased in the last few months, which is levelling out prices.

"That's been really good for first-time homebuyers because they're not competing with 20 other people for properties," he says.

Furthermore, he expects interest rates to remain stable for the next two years. Even with the recent Bank of Canada rate hikes, he says rates have stayed stable.

"In actual fact, the rates have responded in the opposite direction," he says. While variable rates have increased moderately, fixed five-year rates have gone down.

"The bond market affects fixed rates and that market has been down recently."

Yet even if rates remain stable, Canadians will have to face up to their indebtedness at some point, says Sauvé.

"We've got to de-leverage. That's what governments want to do, and that's what businesses have been doing," he says. "Buy now, pay later is not just a slogan -- we eventually have to pay at some point."

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Republished from the Winnipeg Free Press print edition August 28, 2010 A1