It’s no secret that Canadian homeowners have a longstanding love affair with their home equity line of credit (HELOC). However, this love has the potential to go sour through a variety of ways, leaving millions heartbroken.
At the heart of this romance is a low-cost, low interest, and flexible way to borrow money. In the early 2000s, banks began providing a home equity line of credit as a standard addition to new mortgages. Major advantages:
- A much lower interest rate than credit cards (and a much larger borrowing limit
- Homeowners can tap HELOCs for up to 65% of their home’s value
- Most home equity lines of credit have an option that allows interest-only payments
- With each mortgage payment, banks can extend the HELOC term (called a Readavanceable HELOC) so there is no fixed end to it
Historically low interest rates, cooperative banks, and confident homeowners have lead to ballooning borrowing totals. From 2000 to 2010, outstanding home equity lines of credit balances increased from $35 billion to $186 billion. By the end of 2017, that amount had grown to $230 billion – and still increasing.Insert chart here.
By far, the biggest booster of increased home equity lines of credit use have been rising home prices. Between 1999 and 2008, an average house in Canada doubled in value. After a 15-month pause, due to the 2008 Financial Crisis, prices renewed their upward direction:
- From Q2 2009 to Q3 2012, house prices increased by another 24% (17% inflation-adjusted), despite government efforts to cool the housing market
- From Q4 2012 to Q4 2015, tighter mortgage rules implemented in July 2012 helped calm the market, but house prices still rose by around 15.7% (10.8% inflation-adjusted)
- From 2016 to 2017, house prices surged by 22.5% (18.5% inflation-adjusted)
This rapid and record expansion led to increased homeowner confidence. In 2017 alone, Canadians spent nearly $77.7 billion on residential renovations, with $17 billion of new borrowing devoted to them.
Soaring home prices also encouraged home equity line of credit borrowers to spend these freed-up funds on a variety of expensive items. A March 2018 online Globe & Mail survey of 1,521 readers found that:
- 65% had a HELOC and 65% of these have outstanding balances (42% of the total)
- 32% used their home equity line of credit for renovations-repairs, personal expenses, debt consolidation, vehicle purchases, retirement investing or financing small businesses
- 23% used it for living expenses, including bills, vacations and education costs
- 16% paid off or consolidated other debts, including credit cards, which typically have far higher interest rates
- 7% said they used their HELOC to buy a vehicle
Average Mortgage Payments Soar
HELOC borrowers are more vulnerable to economic shocks, such as a job loss or increased monthly payments due to interest rate hikes.
The average mortgage payment is rising quickly in Toronto and Vancouver. Vancouver homeowners had an average payment of $1,794 per month at the end up Q1 2018, up 6.53% from the previous quarter. The average in Toronto reached $1,662 in Q1, up 6.4% from the last quarter. In Montreal, the average payment reached $1,060 in Q1, up 2.51% from the last quarter. Toronto and Vancouver are increasing at nearly double the pace of Montreal.
Irregular Payments = Higher Debt
A 2017 study by the Financial Consumer Agency of Canada (FCAC) showed that 40% of home equity line of credit customers do not make regular payments on the principle and 25% pay only the minimum or just the interest. This has been made possible by ultra low interest rates ranging from 2.75% in 2016, 2.95% in 2017 and now 3.45% in 2018.
Borrowers will then face progressively higher monthly payments. If these increases aren’t budgeted for, or if one’s financial situation stays the same or worsens, cutbacks in other areas will have to make up the shortfall.
Living beyond One’s Means
Although home prices have stabilized in the past year, Canadians are still pursuing excessive lifestyles. Using their HELOC’s low interest rate, debt consolidation can seem a great way to refinance and debt – like a car loan.
When repayment terms are extended from a few years to as many as 30 however, overall interest costs will increase even if the interest rate is significantly lower.
For those lacking financial discipline, debt consolidation creates a false sense of belief that their credit cards are an ATM machine with no accountability: the results? Balances are run up again and their debt problem can escalate.
If there is a job loss in the household, an already stressed home equity line of credit account may not hold up to the added pressure. This is especially so if only interest payments have been made, allowing the principle to grow. If a homeowners’ financial situation is already strained, the sudden loss of income could set off a chain reaction.
Of all the factors affecting home equity loans, interest rates pose the biggest threat due to the forces involved.
How Home Equity Lines of Credit interest rates are calculated
First, it's based on the Bank of Canada prime rate + whatever margin amount a bank or lender deems appropriate, based on value of the home, income, credit rating, etc. Interest rate increases affect people directly via their monthly payments. Currently, the Canadian bank rate 3.45% but that will increase in the coming months, adding incremental expense.
Did you Know
- Banks can raise interest rates on home mortgages whenever they want, without having to give a reason
- Banks can penalize borrowers by applying a higher home equity line of credit interest rate for not allowing the bank to assume their mortgage. This penalty could be as high as 100 basis points (1 full percentage point) more than the bank’s mortgage customers
Complicating Factors: Mortgage Rates
- Each of Canada’s big 5 banks raised their 5-year fixed mortgage rates this past April which adds further pressure to strained household budgets
47% of Canadian mortgages need to be refinanced in 2018 versus the 25%-35% typically, according to Ian Pollick, head of North American rates strategy at Canadian Imperial Bank of Commerce in Toronto
It can be difficult to budget or make future financial plans when your monthly payments or your total borrowing costs increase, in addition to your other expenses.
What Can You Do?
Some common sense tips and advice:
- If you have a home equity line of credit, begin today, to start paying down the principle. You’re fooling yourself if you think that you can go on paying only the interest and emerge from this year unaffected. The likelihood of interest rates increasing sometime in 2018 is high which is going to slowly and painfully jack up your monthly payments
- If you owe money on anything, pay it down. It’s that simple
- Sit down with your spouse and partner and take a long hard look at your lifestyle and taken-for-granted expenses. Make a list of what can be eliminated or re-directed to less expensive alternatives
- Review your current and life priorities and consider how they might be contributing to your money management habits. If you make some changes, it sets in motion other helpful changes
- Examine the reasons you gave yourself for purchases, big and small, over the past 6 months. Were they possibly media-driven? Recommended by friends or family? Of what benefit have they been to you? Were they worth it? Could the purchase have been put off or not made at all? Applying these questions and critical analysis may to decision on spending may prevent an unnecessary purchase in the future. What might be a better destination for that money? Your home equity line of credit, for one