At a time when house prices in Canada’s largest markets are overheating, and total household debt is reaching record highs, HELOCs are an increasingly popular product pushed by banksDarryl Dyc
The consumer watchdog for Canada's financial institutions wants clearer information to help homeowners understand home equity lines of credit, a growing slice of household debt that can tempt borrowers to "use their homes as ATMs."
The Financial Consumer Agency of Canada released a report on Thursday that finds some consumers don't fully grasp the terms attached to HELOCs, which are flexible and low-interest loans secured against the value of a home.
At a time when house prices in Canada's largest markets are overheating, and total household debt is reaching record highs, HELOCs are an increasingly popular product pushed by banks. They are now the largest form of non-mortgage consumer debt in Canada, offering a low-cost way to tap large amounts of credit for expenses such as home renovations. But as banks increasingly offer "readvanceable" mortgages, which link HELOCs with traditional mortgages and other products, the FCAC sees "an important shift" in the way Canadians are choosing to finance their homes.
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The incentive for banks to offer HELOCs to consumers who have equity in their homes is clear: As the loans are secured against property, they're low risk to the lender, which has to hold relatively little capital against them. For savvy borrowers, "it's a product that has a lot of positive features," Richard Bilodeau, the agency's director of supervision and promotion, told reporters on Wednesday.
But in the event of an economic shock – a recession or an interest-rate hike, for example – or any number of personal setbacks such as a lost job or illness, the once-friendly repayment terms on a HELOC can seem onerous.
"They may encourage some consumers to over-borrow, using their HELOCs to live beyond their means and accumulating more debt than they can ultimately afford," said Lucie Tedesco, the FCAC's commissioner.
A report by economists at Royal Bank of Canada argues the real risk around household debt in Canada "is what happens when rates rise." The Bank of Canada has held its key interest rate steady since mid-2015, but has sent subtle signals it may be edging closer to its first rate hike in seven years. RBC points out that while the ratio of owners' equity in their homes to the value of those homes is an impressive 74 per cent, that number drops to between 68 and 69 per cent when amounts owing on HELOCs are factored in.
Fears about the health of Canada's $1.4-trillion mortgage market have intensified of late, as home prices in Toronto skyrocket and troubled alternative mortgage lender Home Capital Group Inc. tries to recover from a crisis. Governments have responded with new measures to try to cool certain markets, including a foreign-buyers tax and new rent-control provisions in Ontario.
On Wednesday, Fitch Ratings warned that high house prices could leave banks more exposed in the event of a "severe economic shock," but thinks Canada's biggest banks "have adequate capital cushions to absorb this risk."
The FCAC report largely steers clear of those broader concerns, which it sees as falling outside its mandate, focusing instead on how well consumers understand HELOCs and the ways banks promote them. It also "didn't really focus on the issue of whether consumers are finding themselves in significant trouble because of HELOCs," Mr. Bilodeau said, because they have low default rates.
After a period of explosive growth, outstanding HELOC balances in Canada reached $211-billion in 2016, up from just $35-billion in 2000. However, average annual growth in HELOCs has slowed to about 2 per cent in recent years.
Federal measures appear to have pumped the brakes. In 2011, HELOCs were deemed ineligible for government-backed portfolio insurance on pooled mortgages. And in 2012, the Office of the Superintendent of Financial Institutions capped HELOC borrowing at 65 per cent of a home's value.
A quarter of consumers only pay the interest or the minimum payment on their HELOCs, while about 40 per cent only make sporadic payments to reduce the principal, according to a 2015 survey by the Chartered Professinal Accountants of Canada cited in the FCAC report. And most homeowners don't repay their HELOCs until they sell their home, eroding the equity they would otherwise have built.
"Traditionally, homes were kind of forced savings vehicles," Mr. Bilodeau said. But the report notes that HELOCs are increasingly marketed as ways to "unlock equity" or "put equity to work."
The FCAC plans to impose new, unspecified standards for better disclosure on financial institutions, to help ensure homeowners know what they're signing on for.
"What our complaints have shown are people are not understanding the product," Ms. Tedesco said. "It's not that they've been bamboozled."