With interest rates on the rise, there could be a reckoning coming for Canadians with hundreds of billions in debt
Given the heady highs of the housing markets just a few years ago, it is easy to understand why many Canadians have opted to squeeze cash value out of their homes with home equity lines of credit (HELOCs). A difference in generational incomes, with Generations X and Y earning less than Boomers did at their age, has also been a factor.
But as interest rates proceed on an upward trajectory, many Canadians with HELOC debt are probably coming to regret it. “HELOCs are subject to interest rate rises because it’s a line of credit,” explained Scott Terrio, a manager of consumer insolvency at Hoyes, Michalos & Associates, to Toronto Storeys. “But I think very few people really looked into the fine print of the HELOC.”
According to Terrio, HELOCs were essentially meant to be used for home renovations, but have ended up being used for consumption and luxury expenses. Lenders have viewed people with homes as more credit-worthy than renters; Terrio estimated that renters tend to have unsecured debt in the mid-$40,000 range, while homeowners have around $30,000 more than that.
“Right now, 3.1 million Canadians have HELOCs,” he said, noting that a HELOC could have a balance of $100,000 to $200,000. “Something like a third of people with HELOCs pay only interest. The average balance is about $70,000.”
Aside from the temptation to consume, Terrio said HELOC-laden homeowners are at risk because there is no requirement to pay their debt back, unlike mortgages that come with clear amortization schedules. That structure, he implied, represents a great test of financial responsibility that the majority would fail, especially “in an expensive city like Toronto or Vancouver.”
He also suggested that Canadians have a disproportionate appetite for HELOC debt. He estimated the total HELOC debt in the US to be $370 billion, while Canada, which has around one-tenth as many people, has about $230 billion.
New HELOC rules have been handed down to rein in the problem. As opposed to the previous requirement for people to be approved on their balance, now approval depends on one’s limit; in other words, the stress test now looks at an individual’s maximum rather than what they’ve got.
“The problem is it’s too late,” Terrio said. “They should’ve done that five years ago. The horse is out of the barn.”
The Bank of Canada started to raise interest rates from extreme lows in 2016, but he believes the bank will pause if they see Canadians start to panic. But assuming the low-rate regime ends sooner rather than later, so could the near-decade lull in insolvency filings.
“I think 2019 and 2020 are going to be the years where it’s going to come apart,” Terrio warned.