It’s not just skyrocketing real estate prices that have regulators worried. It’s also the fact consumers have been tapping the swelling equity in their homes and don’t seem to be in a hurry to pay it back. In fact, many are only covering the interest payments, which are at near-record low rates. The Financial Consumer Agency of Canada is out to raise awareness of this problem, with a warning that carrying more debt for longer could “put stress on Canadian households, at a time when they are carrying record amounts of debt.”
Essential bank jargon: Two terms the FCAC wants you to wrap your head around are “HELOCs” (home equity lines of credit) and “readvanceable mortgages” (an unfortunate mouthful that refers to term mortgages wrapped up with HELOCs and sometimes other products such as credit cards). Canadians are bingeing on HELOCs, with much encouragement from the banks, and the FCAC says readvanceable mortgages have become the default mortgage choice for anyone who has put down 20%.
Alarm bells: There are about three million HELOCs in Canada and 80% are held under readvanceable mortgages, the FCAC reports. Altogether, there are HELOC balances of more than $200 billion today, which poses a substantial macro risk to the economy. Traditional mortgages are structured with a plan to pay them off, but 40% of consumers don’t make regular payments toward their HELOC principal and 25% either pay only the interest or make the minimum payment. “Most consumers do not repay their HELOC in full until they sell their home.”
A growing debt …
… that consumers are reluctant to pay off:
Bottom line: The potential impact depends on what exactly consumers are doing with the money they borrow against their homes. If they are borrowing at 4% and investing it in the stock market and making 10% then they come out ahead. If real estate prices keep rising quickly, they can also come out ahead. But if they are spending them on vacations, home renos or buying a boat, that could backfire. And the risks rise sharply if housing prices drop substantially, leaving your payments the same but reducing your equity. A bigger risk would be a double whammy of higher interest rates and a decline in real estate values. And a triple whammy would be borrowing to invest in the stock market, then watching stocks fall, rates rise and housing prices drop. That’s how leverage can bite. Visit the FCAC’s site to learn more about fees, disclosures and other risks of using HELOCs.
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