Last week’s Q&A about Home Equity Lines of Credit, or HELOCs, sparked some online chatter among readers — and a lot of questions.
There’s nothing inherently wrong with HELOCs for borrowers that have the means and a plan to repay the debt. But Scott Terrio, manager of consumer insolvency at Hoyes, Michalos & Associates, believes many Canadians do not understand the full implications of HELOCs — and that this type of debt is offered too easily to them.
Toronto Storeys followed up with Terrio to lay out the key issues around Canada’s HELOC addiction.
1. A HELOC is a secured line of credit — a loan using equity in your house — that does not have an amortization.
“When you get a mortgage, you know exactly for 25 years exactly what’s going to happen every month,” Terrio says. “With a HELOC, you don’t.”
Mortgages require homeowners to pay down a certain amount of the principal debt every month. Without an amortization, HELOCs allow borrowers to make interest-only payments — and roughly a third of Canadians with HELOCs are doing just that. This means HELOC debt can linger for years, or decades, without making any headway.
Terrio points out that many of his clients struggle with the difference between unsecured and secured debt. Unsecured debt includes credit cards and unsecured lines of credit; secured debt includes mortgages, car loans and HELOCs.
“It’s a secured line of credit, that’s the big thing,” he says. “Anything secured — if you don’t pay it, the lender can take the security.
“If you don’t pay your mortgage, the security is your house. So, they can either go power of sale or foreclosure, depending what province it is and so forth. If you don’t pay your car loan, they can repossess the car. Security is always the discretion of the lender.”
Terrio points out that there are laws governing secured debt, but banks still have a lot of leeway.
“They write their own wording into (the HELOC), and no one reads it.”
2. Banks can change the rules, including raising interest rates, at any time.
“That’s probably one of the biggest points in all of this,” Terrio says. “A HELOC is fully open, the bank can change the rules at any time, they can roll it into an amortization of your mortgage when they want to. I don’t think people appreciate what they’re subject to.”
Terrio says banks can raise interest rates at their discretion — with notice — because rates aren’t locked in, as they are with mortgages.
Banks can also call the HELOC: ‘calling’ a debt is when a lender says the borrower has to pay back the debt, or a portion.
“The people I’ve seen in my office that have HELOCs, when I tell them these are fully call-able, they are shocked by that,” he says. “Can a bank make a call on the principal (balance)? Yes, sure they can. They can call the whole HELOC.”
Terrio adds that it’s unlikely banks will suddenly start calling HELOC debt from millions of Canadians — the result of which could be catastrophic, considering our record-high HELOC debt. “They’re not going to tank their own profits,” he says, or “raise hell in the market.”
But Terrio says banks can examine their total HELOC debt exposure and select some debt for revision.
“And so, the credit cycles turn, and the banks start to get nervous, and then they start to change the rules.”
3. If house prices drop, you still owe the HELOC debt. You may even be underwater.
“If house prices dropped enough, there are going to be people who are underwater,” Terrio says. “In fact, there are people in the outer rim in Toronto — like Markham and Richmond Hill, where they were hit the hardest by housing drops — there are people who are already underwater.
“Now, being underwater doesn’t mean anything, it just means you owe more than your house is worth. As long as you keep paying your mortgage, nobody cares.”
The HELOC debt remains — you still have to pay it back. But, per the previous point, Terrio says that drops in home values mean the banks can react.
“If house prices go down enough, the banks get nervous. And when the banks get nervous and you have a fully open lending vehicle, you’re in trouble. They can change the rules on the fly.”
4. HELOCs are attractive to homeowners because housing feels safe — but it’s a false sense of security.
“There’s a great deal of temptation with HELOCs that is not present with other debt,” Terrio says. “With house prices having gone up like crazy in the last few years, people have become suddenly very wealthy on paper.”
But interest rate rises and drops in home values, he adds, can make a large HELOC debt dangerous.
“For three or five years there, it was great. But now prices are going down and people are realizing, whoa, you can lose equity just as fast as you can make it.”
Size matters, too — Terrio points out that most debt from credit cards or other lines of credit is around $10,000 to $20,000. On average, HELOCs are up to four times that amount. That can make interest rate increases crippling to the average household.
5. Banks love HELOCs.
“This is a two-edged sword. There are always two parties in lending. People went nuts for HELOCs but the banks also went nuts giving them out,” Terrio says. “It’s secured. It’s like the greatest thing ever for the bank, because the equity is already there.
“There’s a couple of banks that are notoriously HELOC-crazy, and I’m not going to name them. But they are really exposed. It just shows you that it goes bank by bank.”
Terrio thinks some banks have made it too easy for homeowners to rack up vast sums of debt. He’s seen instances where borrowers were even given a card to swipe whenever, wherever they wanted.
“They just make it way too easy,” he says. “If you get a second mortgage, you have to go (to the bank to negotiate). But with HELOCs, they let you use it like a bank account. You don’t have to ask them, you just use it.
“It’s like — here’s $100,000 dollars in the hands of a 35-year-old in Toronto.”
6. HELOCs were originally intended for home renovations — a short-term cost that likely increases the value of the house.
“Traditionally, going back far enough, it was meant to be an additional borrowing tool against the equity of your house,” Terrio says. “Kind of like a second mortgage. And I think the early notion of it was you would do improvements on your home, so ultimately you could sell it for more, so you end up with the money some day.”
But, as Terrio has seen in his consumer insolvency firm, people are using the debt to maintain lifestyles — expensive vacations, private school, luxury cars or boats.
“The luxury pets or the ski trips aren’t ever going to pay you back,” he says. “If you renovate your kitchen, that’s a no-brainer. When you go to list your house someday, you wouldn’t have listed it for that much if you didn’t have a chef’s kitchen.”
7. HELOC debt contributes to household debt, which is critically high in Canada — which in turn may threaten the economy.
Canadians owe $1.78 for every dollar of disposable income they have, the CBC reported in December. “We’ve gone from $1.60 to $1.78 in debt-income ratio, which is pretty insane,” Terrio says.
How could this spark a financial crisis? As interest rates edge upward, it may reach a breaking point for Canadians’ budgets.
If a Canadian family has a mortgage, credit card debt, other lines of credit, and a massive HELOC — the average balance is $70,000, Terrio points out — the interest increases alone can suddenly cripple their finances.
Depending on the size of the household debt, interest increases can mean $200, $300, or even $500 more every month.
“If that many people are out there living on the edge — as we’ve seen, study after study — then $200 or $300 (a month) is going to matter,” Terrio says. “Everybody has a breaking point.
“Economies come down to what people can spend. If the average Canadian family has no spending ability in 2019 or 2020 … then good luck with the economy.”
- Canada’s HELCO debt is a record $230 billion
- More than 3 million Canadians have HELOCs
- Roughly a third of Canadians with HELOCs are only paying interest
- Average HELOC balance: $70,000
- Canadians owe $1.78 for every dollar of disposable income they have
- Our debt-to-income ratio is at record levels, doubling in the past two decades