Be wary of home equity lines of credit
A federal agency is warning consumers addicted to home equity lines of credit (HELOC) — a product increasingly driving debt — could find themselves at increased risk of default if the housing market corrects.
“Falling housing prices may constrain HELOC borrowers’ access to credit, forcing them to curtail spending, which could in turn negatively affect the economy,” the Financial Consumer Agency of Canada (FCAC) wrote in a 15page report out Wednesday. “Furthermore, during a severe and prolonged market correction, lenders may revise HELOC limits downward or call in loans.”
The timing of the release from FCAC is coincidental but it comes just two days after the Toronto Real Estate Board reported new data that clearly show the housing market in retreat. May sales dropped 20.3 per cent from a year ago and prices were off 6.2 per cent from April amid a massive surge of active listings.
The report, titled Home Equity Lines of Credit: Market Trends and Consumer Issues, focuses on the massive explosion of the HELOC market which grew from about $35 billion in 2000 to $186 billion by 2010 for an average annual growth rate of 20 per cent.
During that period, HELOC became the fastest growing segment of non-mortgage consumer debt. In 2000, the HELOC market made up just 10 per cent of non-mortgage consumer debt but had climbed to 40 per cent by 2010.
“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. HELOCs may lead Canadians to use their homes as ATMs, making it easier for them to borrow more than they can afford,” said Lucie Tedesco, commissioner of the FCAC. “Consumers carrying high levels of debt are more vulnerable to the impact of an unforeseen event or economic shock.”
The average annual growth of the HELOC market slowed to five per cent from 2011 to 2013 and has averaged two per cent since, the slowdown at least partially attributable to tougher federal guidelines on how much home equity consumers can access through a HELOC.
HELOC products have become popular because they work like credit cards or unsecured lines of credit, in terms of the ability to draw money from them. They are usually backed by a collateral charge on your home but a HELOC most often gives the consumer the ability to withdraw and pay off their HELOC with flexibility — financed at a rate which is usually close to the prime lending rate at most banks.
Unlike a mortgage, a HELOC is a demand loan, and while most borrowers can pay interest-only on them, the loans are callable by the bank at any moment — a practice rarely seen in the Canadian market at this time.
A positive feature of a HELOC is the ability to consolidate highinterest debt from items like credit cards, and the report says from 1999-2010, 26 per cent of loans were used for just that. Another 34 per cent were used for financial and non-financial investment. The remaining 40 per cent was used for consumption or home renovation — a market Altus Group said was worth $71.4 billion in 2016.
The federal agency noted that most HELOC products sold today are part of what is called readvanceable mortgage. In those cases a HELOC is combined with the mortgage and as the mortgage is paid down, the available credit in HELOC increases.
“In recent years, lenders have been strongly encouraging consumers to use readvanceable mortgages to finance their new homes,” said Tedesco.
She said complaints have shown people are not understanding the product. “It’s not that they’ve been bamboozled,” said Tedesco. “One of the things that we will be doing with the results of our research is trying to see how we can improve the disclosure around readvanceable mortgages, and will communicate to the financial institutions our expectations on that front.”