Are HELOC’s being used in Canada?
The popularity of Home Equity Lines of Credit (HELOCs) has exploded in recent years. Earlier this year, Canadians set a new record for HELOC balances, with a combined $260 billion outstanding. Based on a population of approximately 38 million people in Canada, that works out to an average of nearly $7,000 per Canadian!
This total continues to grow, as the number of new HELOCs taken out by Canadians in the second quarter of 2021 was the highest in 10 years, and 56.7% higher than the number from the same quarter a year earlier. Given that Canadian house prices have soared recently, this growth in the quantity and size of HELOCs in Canada really comes as no surprise. As house prices rise, so too does the amount of house equity that Canadians are able to extract as cash through the opening of a HELOC.
Why would I use a HELOC?
Many people prefer HELOCs to a traditional home equity loan or an outright remortgage – because like other lines of credit, most HELOCs only require monthly interest payments with no fixed repayment reschedule for the principal. This allows the debtor to repay as much or as little as they would like each month, providing the maximum flexibility for their cash flow situation.
What are HELOC’s being used for?
The funds that the home owners withdraw from HELOCs are used for many things. One common use is to fund home renovations. In such instances, the market value of your house is likely increasing by the same amount of the debt you are incurring. This means that there is really no change to the net equity (value of an asset less debt secured against that asset).
Sometimes the equity is “cashed out” and used for purposes unrelated to the home from which the equity is withdrawn. One example of this is using the funds to purchase a cottage or other vacation property, which traditionally have been more difficult to finance than a standard house in a city or town.
Another example is using the HELOC funds to provide a gift to one’s children to enable them to purchase a house despite high house prices.
One further use of HELOC funds, and one that seems to be becoming more common, is to pay down other debt. In many cases, the HELOC funds are used as a debt consolidation mortgage, and have even allowed some people to avoid Bankruptcy.
Is it a good idea to use a HELOC to pay down debt?
In principle, taking out a HELOC to pay down other debt makes good financial sense. Being that a HELOC is secured against your house, it generally represents very little risk to the lender. After all, if the debt isn’t repaid, the sale of the house will often recoup the debt, especially in the current market. As such, the lender is able to issue a loan at a rate that will usually be much lower than the riskier unsecured debt that you are trying to pay off.
This means that, if all else is equal, more of your monthly payments will go towards the principal, allowing you to be debt free sooner. The higher the interest rate on your unsecured debt, and the lower the interest rate available on your HELOC, the more using a HELOC to consolidate your debt makes sense. It also adds the convenience of replacing several payments with a single HELOC payment.
What are the risks of using a HELOC?
Despite the benefits of HELOCs, which lead to their widespread appeal, there are some pitfalls to be aware of. These basically fall into two categories of risks. They are:
1. Housing prices could change
The amount that a lender will allow you to borrow on a HELOC is largely dependent on the equity in your house. Banking regulations require that the amount available on a HELOC is capped at an amount that, when combined with your mortgage, represents 65% of the purchase price or market value of your home.
Of course, the market value of your home is not a stationary number. When it rises, the amount available under a HELOC grows, but if it falls, the opposite is true. This has the potential to present a few problems.
For example, if there was a widespread reduction in house values in your area, it is possible that the bank could reduce the amount available to withdraw from the HELOC to better reflect the current equity available. This means that money you had counted on, as an emergency fund, for example, is not available when you need it. It also means that, when the time comes, you may not be able to renew your mortgage if the value of the house is no longer sufficient to secure the debt.
If housing prices fall, you could also end up with negative equity. Negative equity, colloquially known as being “under water”, means that the debt secured against an asset is greater than the value of the asset itself (your house, in this case). The bigger the HELOC that you have, the more likely this scenario is.
When you file a Bankruptcy or a Consumer Proposal, it is common for you to be able to keep your house. However, this is generally only possible if you agree to continue paying the mortgage and any other debts that are secured against that house, including a HELOC. If you have negative equity and wish to retain your home, you will be retaining mortgage and HELOC balances that are greater than the value of your home, regardless of a Bankruptcy.
2. Interest rates could change
Not only is the market value of your home subject to fluctuations, so too is the interest rate on your HELOC. Most HELOC rates are based on your bank’s “prime rate”. The prime rate is variable, with changes linked to an interest rate set by the Bank of Canada, and so too would be your line of credit rate.
The Bank of Canada rate is currently at a record low, having been there since around the start of the Covid-19 pandemic. As such, many believe that it can only go up, and there is talk that recent increases in the rate of inflation could force the Bank of Canada to raise the rate sooner rather than later.
When your bank’s prime rate increases, so too will the required monthly payments on your HELOC if you are only paying the interest portion. This is different from a fixed rate mortgage, where your interest rate and payment usually only change upon renewal or switching lenders. If you are considering a HELOC, make sure that you will be able to afford the payments even if interest rates rise.
How do I qualify for a HELOC, and if I don’t qualify – what can I do?
Of course, not everyone qualifies for a HELOC. In order to obtain one, you will need the aforementioned equity in your house, sufficient income to cover your debts, and a decent credit score. If your situation is such that lenders are denying your applications for a HELOC, or are only granting them at interest rates that are not affordable, it is advisable to examine what other options are available to you for dealing with your unsecured debt.
The best person to do this with is a Licensed Insolvency Trustee, such as those at LCTaylor. We offer a free, no-obligation consultation that will outline the options that you have and assist you in improving your financial future. Call us today at 204-925-6400 or send us an email at questions@lctaylor.net.
Daniel Maksymchak, LIT
