Home equity lines of credit: easy money or a double-edged sword for Canadians?
Springtime leads to impulse purchases. From sleeker appliances and 72-inch home theatres to a motorcycle and even a boat, Pierre Leblanc, CPA, CMA, CIRP, has seen it all. The insolvency expert has a front-row seat at his firm Groupe Leblanc Syndic, which has 21 offices in the Greater Montreal area. Since it was founded in 2004, the firm has helped more than 15,000 people climb their way out of debt. What’s one of the main causes, according to him? Home equity lines of credit (HELOCs), which give people access to easy money.
And Canadians have not shied away from them. Between 2000 and 2016, total outstanding HELOC debt rose from $35-billion to $211-billion, growing by 20 per cent on average each year over a decade, before levelling off at 5 per cent and, more recently, at 2 per cent. In concrete terms, there are close to three million HELOCs across Canada, with an average balance of $70,000.
There’s no denying their appeal. HELOCs are a credit product secured by your home. The more you pay down your mortgage, the more money you can “re-borrow” at a preferential rate (generally 1 per cent above your mortgage rate, and up to 80 per cent of the value of your collateral). What goes in one end comes out the other.
Used wisely, a HELOC can let you do a lot: pay for renovations (which can increase your home’s value) or education, invest (buy a second home), consolidate your debts, if necessary, and pay down the balance on your high-interest credit cards.
The money is available immediately and, unlike a mortgage, you can pay just the interest, and not the loan principal—“a short-term advantage that can become a long-term problem,” according to the Financial Consumer Agency of Canada. For example, imagine if your home loses value after you’ve borrowed too much against it. You can end up owing more than the house is worth.
This isn’t an unlikely situation. “Many people no longer make their mortgage a priority, betting instead on their home’s increase in value over time,” Leblanc says. “Twenty years ago, people paid down their mortgage in 25 years. Today, we see people who, after dipping into their line of credit, owe as much or more 20 years later than they did at the time of purchase. In short, they’re poorer.”
How does it work? Most financial institutions stipulate in the initial contract that all amounts repaid on a conventional mortgage can become available through a line of credit. That means you can recover the amounts when your current account balance is zero. Your home becomes an ATM of sorts with a dedicated debit card.
“Some people, after paying down $2,000 on their mortgage, will recover the $600 or $800 that becomes available through their HELOC,” Leblanc explains. “They want to treat themselves to something nice, and don’t realize that the extra $100 or $200 they have to pay each month on their line of credit only covers interest. In many cases, they won’t be able to pay down the principal until they sell their home,” he says.
The numbers speak for themselves: 40 per cent of Canadians do not make regular payments toward their HELOC principal, and 25 per cent only pay the interest. We often hear about Canadians’ average debt-to-income ratio, which currently stands at 170 per cent. As Bank of Canada Governor Stephen Poloz pointed out in early May, “About 8 per cent of indebted households owe 350 per cent or more of their gross income, representing a bit more than 20 per cent of total household debt.”
What will happen if the Bank of Canada raises its key interest rate by 1 per cent in the next 12 months, as some economists have predicted? “People don’t have any leeway. We see many retirees who have overestimated their government benefits and, on top of that, have gone into debt to look after their children or grandchildren,” Leblanc says. Others are eyeing the labour market, because they need two sources of income to pay down these debts.
Should the amounts people qualify for be revised? Discipline is crucial, answers Leblanc. “It’s a product that requires a great deal of caution. It’s like a hammer: it can be very practical, and it can also do a lot of damage if you don’t know how to use it.”