Rising interest rates and efforts by policymakers and regulators to tame climbing residential real estate prices are prompting concerns about the ability of Canadians to manage popular and widespread home equity lines of credit.
Research conducted by the Financial Consumer Agency of Canada suggests plans to pay off the loans, which make up a significant portion of non-mortgage consumer debt, are optimistic.
New public opinion research confirmed the consumer agency’s earlier findings, which revealed one-quarter of the HELOC holders have been paying only the interest on these loans most months. That means they haven’t been paying down the principal on this debt, which will be subject to the higher rising interest rates.
“We have already identified a pressing need for us to help Canadians realize that not using HELOCs responsibly can have serious repercussions on their financial well being,” FCAC Commissioner Lucie Tedesco warned in a recent speech to mortgage professionals in Montreal.
Just over 60 per cent of those surveyed by the FCAC who were paying only interest said they planned to pay off their lines of credit over the next five years, but Tedesco suggested that was “overly optimistic,” particularly given that the average Canadian HELOC balance is $70,000.
Jason Mercer, a vice-president and senior analyst at Moody’s Investors Service, said higher debt-servicing costs driven by rising interest rates are a concern.
“If the consumer is barely making regular payments today, they will likely not be able to keep up with higher monthly payments – unless they pay down more of the HELOC,” said Mercer, who tracks mortgage and related debt for the credit-rating agency.
If the consumer is barely making regular payments today, they will likely not be able to keep up with higher monthly payments
Jason Mercer, senior analyst, Moody’s
This concern is separate from more hypothetical risk factors around HELOCs, such as rising unemployment levels and falling house prices, he said.
The FCAC isn’t the only market watchdog to sound the alarm on the HELOC, which has grown in popularity amid prolonged low interest rates and soaring house prices that provided the equity to back larger loans.
Bank of Canada Governor Stephen Poloz included concerns about how Canadians were using their HELOCs in a speech last December among things that keep him up at night.
Lines of credit secured by homes were initially marketed by banks as way of obtaining cheap and easy access to funds to pay for home renovations that would help maintain or increase the value of the home. But the funds are not limited to home improvement, and, as the FCAC noted in a report last year, have be used to fund the purchase of depreciating assets, such as cars, and even speculative stocks.
As a result of factors including low interest rates, rising housing prices and significant spending on marketing HELOCs, balances grew to $186 billion in 2010 from just $35 billion 10 years earlier. Over the same period, these loans grew to represent 40 per cent of non-mortgage consumer debt, up from 10 per cent. By the end of 2017, that balance had climbed to $230 billion, according to the Office of the Superintendent of Financial Institutions.
Rob McLister, founder of mortgage comparison website RateSpy.com, says policymakers are keen to pull in the reins on HELOCs because of concerns that the borrowing binge could have repercussions for the broader mortgage market and economy.
“To the extent over-borrowing makes consumers less likely to repay their mortgages in an economic shock, that adds to systemic risk,” he said.
There are further “systemic” concerns because heavily indebted households tend to cut back on spending in the event of an economic shock, such as the collapse of oil prices, which in turn reduces demand for consumer goods, which can trigger increasing unemployment and reduced investment.
“Any time you get multiple federal agencies (such as the FCAC and Bank of Canada) issuing worrisome reports on the growing risk of a financial product, it’s just a matter of time before that product sees new restrictions,” McLister said.
But he said policymakers should keep in mind that HELOCs can provide an effective fall-back measure for households, rather than “letting money waste away” in an emergency fund, and they are rarely called in by a financial institutions when a borrower is in good standing.
Solving this with over-regulation is like legislating consumption limits on French fries because they contribute to heart disease. Ultimately people need (to take) some personal responsibility
Rob McLister, RateSpy
“The biggest problem with HELOCs is their ability to delay retirement for debt-a-holics,” McLister said, noting that paying down a mortgage is often a form of forced savings that funds the cost of living in retirement.
“Solving this with over-regulation is like legislating consumption limits on French fries because they contribute to heart disease,” he said. “Ultimately people need (to take) some personal responsibility.”
Mercer, the Moody’s analyst, said banks are likely to work with clients struggling to pay off their HELOCs, such as by combining the lines of credit with mortgages and rolling both into a new amortizing structure the consumer can afford, thereby closing out the HELOC.
Some industry watchers suggest rising interest rates, combined with the added scrutiny on HELOCs from regulators and policymakers, could also prompt banks to consider changing their behaviour even in the absence of new rules. This could include tweaks to underwriting policies and new lending restrictions.
In an emailed statement in response to questions about HELOCs and the recent concerns raised by the FCAC, the Canadian Bankers Association said its members run internal stress tests on lending models that factor in interest rate increases, as well as the potential for rising unemployment, but these reports and their conclusions are not made public.
In addition, the statement said, the banks “prudently” adjudicate and underwrite all home equity loans and lines of credit.
“Before granting a home equity loan or line of credit, banks complete a thorough due diligence process, including the likelihood that the applicant will be willing and able to meet their loan obligations on a timely basis and that the property, which is offered as security, is appropriately valued,” the CBA said.