If you asked me what Canada is known for, I’d tell you the Rocky Mountains, maple syrup, and home equity lines of credit.
There are few things quite as patriotic as borrowing against the equity in your primary residence, and YOLO-ing that debt into home renovations, investment properties and the stock market. And those are the most responsible uses. You’d be hard pressed to find a Canadian borrower who hasn’t quietly consolidated some credit card debt or wiped out a student loan by borrowing against their home equity.
The statistics reflect our addiction: Canadians now owe $168.5-billion in HELOC debt. Borrowers took out $2-billion in HELOCs in February alone, the highest single-month increase since 2012. For most Canadian homeowners, a HELOC is their own personal ATM, funding everything from personal emergencies to family vacations.
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A HELOC allows homeowners to borrow up to 65 per cent of their home’s purchase price or appraised value on a revolving line of credit to spend at their discretion. Exactly how much you can take out in a HELOC depends on the amount of equity you have in your home.
Major financial institutions will often offer a HELOC with the mortgage when you buy your home, giving newly minted homeowners the opportunity to immediately diminish their net worth should they choose. And choose, they do.
Home equity lines of credit are promoted as an attractive source of cheap credit that can be used for a multitude of applications. New homeowners justify ringing up their lines of credit for renovations that will “add value to their home.” Stock market enthusiasts gleefully borrow in order to employ the tedious Smith Manoeuvre to reduce income taxes. Canadians burdened by credit cards or student loans breathe easy as the balances are wiped clean with a single transfer to consolidate their debts. The debt doesn’t disappear, of course, but it has gone somewhere else and they don’t have to think about it.
HELOCs have made Canadians complacent with debt, then greedy for it, and finally it has became one of our defining characteristics. Our country’s HELOC balances have tracked the Canadian debt-to-income ratios nearly perfectly for the past two decades. No wonder: They are now the main driver of our household debt burden.
Prior to 2000, the ratio of debt-to-income in Canadian households remained relatively constant. But then growing HELOC balances in the years that followed resulted in exponential growth of household debt, transforming Canada into a global leader when it comes to over-leveraged citizens.
Compare this with the U.S., where HELOCs have been in decline since 2008. Both American banks and consumers alike seem reluctant to borrow against their home equity after the housing bubble collapse caused the Great Recession in 2009.
In 2019, the Financial Consumer Agency of Canada found that the average HELOC balance was already $65,000, and as many as one in four borrowers were carrying a balance of more than $150,000. These numbers are undoubtedly higher now. FCAC also found at as many as one in five homeowners borrowed more than they intended.
But most troubling of all, the vast majority of respondents scored less than 50 per cent in a test about HELOC terms and conditions, suggesting that the average borrower doesn’t even understand how these financial instruments work.
In an era of cheap credit, incredible stock market returns and mind-boggling real estate gains, we’ve forgotten that HELOCs are debt, and that carrying debt inevitably comes with risk. Unfortunately, now it seems Canadians are headed for a reckoning.
HELOCs have variable interest rates, which means they are sensitive to interest rate increases by the Bank of Canada. As rates rise, so does your cost of borrowing and your monthly payment. HELOCs don’t require fixed payments that pay down the principal balance, which is one of the reasons their debt burden has not been felt as readily as a car loan or a credit-card bill. Instead, borrowers make interest-only payments and have the option to pay extra if they want to reduce their balance.
But at a time when inflation has increased the prices of everything from gas to groceries, it’s likely that overleveraged households do not have the slack in their budgets to absorb even the slightest increase in HELOC payments. Last month, the Bank of Canada raised its benchmark lending rate by 50 basis points to 1 per cent. Additional raises are projected in the coming months, with the rate expected to finish the year at 2 per cent or 2.25 per cent.
While the difference between 1 per cent and 2 per cent might seem small, for HELOC borrowers it means their interest-only payments will double. If they used their HELOCs to fund investment properties that have fallen in value, or buy stocks whose prices have collapsed by double digits, then they’re in for even more pain unless they change course.
The solution? The only one is to take on the most un-Canadian of tasks, and make paying off your HELOC your main financial priority. It may feel unpatriotic, but you cannot afford to be the average Canadian any more.
Bridget Casey, MBA (Finance), is founder of Money After Graduation, a financial eLearning company. You can follow her on Instagram & Twitter at @BridgieCasey
Bridget Casey