In recent years, Canadians have taken advantage of growing and elevated levels of equity in their homes to take out home equity lines of credit.
The popularity of home equity lines of credit (HELOC) is unmistakable as it’s estimated that about three million Canadians use this borrowing method today. But it’s also led to record levels of within-Canada household debt.
Many Canadians may be at risk because of over-borrowing — a problem now being made worse by rising interest rates.
“At a time when consumers are carrying record amounts of debt, the persistence of HELOC debt may add stress to the financial well-being of Canadian households,” says Lucie Tedesco, Commissioner of the Financial Consumer Agency of Canada (FCAC).
“HELOCs may lead Canadians to use their homes as ATMs, making it easier for them to borrow more than they can afford. Consumers carrying high levels of debt are more vulnerable to the impact of an unforeseen event or economic shock.”
The growing popularity of HELOCs since the 2000s has been an important driver behind the expansion of household debt, says the Agency, adding that outstanding HELOC balances reached $211 billion in 2016. HELOC accounts in Canada have an average outstanding balance of $70,000.
In its report Home Equity Lines of Credit: Market Trends and Consumer Issues, FCAC says lenders are increasingly offering readvanceable mortgages, which combine term mortgages with HELOCs and other credit products.
“Readvanceable mortgages are complex. The report found that many consumers would benefit from more and clearer information about how readvanceable mortgages work, the applicable fees, terms and conditions, and the risks potentially involved,” says the Agency. To that end, FCAC is providing Canadians with information about borrowing against their home equity, along with useful financial planning tools, at canada.ca/it-pays-to-know.
Before deciding to use a HELOC
There are some important considerations you should make before you decide to use a home equity line of credit.
• Determine whether you need extra credit to achieve your goals, or if you could build and use savings instead.
• If you decide you need credit, consider things like flexibility, fees, interest rates and terms and conditions.
• Make a clear plan of how you’ll use the money you borrow.
• Create a realistic budget for your projects.
• Determine the credit limit you need.
• Shop around and negotiate with different lenders.
• Create a repayment schedule and stick to it.
Advantages of using a HELOC
There are some advantages of home equity lines of credit, FCAC acknowledges.
• Easy access to available credit.
• Often lower interest rates than other types of credit (especially unsecured loans and credit cards).
• You only pay interest on the amount you borrow.
• You can pay back the money you borrow at any time without a prepayment penalty.
• You can borrow as much as you want up to your available credit limit.
• They’re flexible and can be set up to fit your borrowing needs.
• You can consolidate your debts, often at a lower interest rate.
Disadvantages of using a HELOC
There are also some unique disadvantages of home equity lines of credit, according to FCAC.
• It requires discipline to pay them off because you’re usually only required to pay monthly interest.
• Large amounts of available credit can make it easier to spend higher amounts and carry debt for a long time.
• To switch your mortgage to another lender you may have to pay off your full home equity line of credit and any credit products you have with it.
• Your lender can take possession of your home if you miss payments even after working with your lender on a repayment plan.
“When used responsibly, the HELOC portion of readvanceable mortgages can provide many benefits to consumers such as low interest rates, convenient access to funds and flexible repayment terms. However, it also allows consumers to make interest-only payments which can result in homeowners carrying debt for longer periods,” sayd FCAC.
FCAC found that the number of households that have a HELOC and a mortgage secured against their home has increased by nearly 40% since 2011; 40% of consumers do not make regular payments toward their HELOC principal; 25% of consumers pay only the interest or make the minimum payment; and most consumers do not repay their HELOC in full until they sell their home.
“Consumers carrying large amounts of credit at variable interest rates are particularly susceptible to rising interest rates. These consumers may be significantly more vulnerable if a large share of their disposable income is applied to servicing their debt, since they may lack adequate flexibility in their monthly budget to cope with higher borrowing costs. Consumers without adequate emergency funds are also more vulnerable to payment shock, and recent surveys have found that almost half of working Canadians are living paycheque to paycheque without enough set aside to carry them through in the event of an emergency or loss of income,” says FCAC.
FCAC cites a TransUnion report indicating that roughly 720,000 Canadian consumers would experience difficulty meeting their credit obligations if interest rates rose by only 25 basis points. Nearly one million consumers could experience payment shock if interest rates were to rise by a full percentage point, or 100 basis points.