With the central bank set to raise lending rates today, mortgage holders have been warned to expect more expensive debt than they’re used to. Just as worryingly, other forms of debt are even more vulnerable to impending rate hikes.
In recent years, home equity lines of credit (HELOCs) have become popular among homeowners eager to convert their considerable house price gains into usable cash. Using a HELOC, a lender allows a borrower to withdraw a certain amount of money against the equity in their home, with interest rates tending to vary between 0.5 and two points above prime. -- making HELOCs a little more expensive than mortgages.
Consumers favour HELOCs because of their convenience. Many allow borrowers to make payments against the interest with no obligation to pay down the principal each month, and homeowners enjoy the access to some of their homes’ equity gains without having to move, according to Laurie Campbell, CEO of Credit Canada.
“A generation ago, you'd get a mortgage and pay it off. Now you get a HELOC and treat your home like an ATM,” she said.
Currently, there are roughly three million active HELOCs across Canada, with an average balance of about $70,000, according to the Financial Consumer Agency of Canada (FCAC).
When used responsibly, HELOCs can “provide many benefits to consumers such as low interest rates, convenient access to funds and flexible repayment terms,” the FCAC said.
Nearly 40% of people who get HELOCs make no regular payments against the principal, the FCAC said. This exposes them to financial stress when rates rise.
“It's a hidden problem, because with rising house prices, many people took out HELOCs with no intention of paying them off. So today, they owe as much on them as they did three or four years ago,” Campbell said.
Most HELOCs are set at variable rates, which ensure they’re in sync with any looming central bank rate hikes. HELOCs also happen to be “demand loans,” meaning the lender can call them in at any point and insist the borrower pay back the full amount.
With uncertainty growing around house prices, lenders are unlikely to call in these loans and trigger a panic. Nevertheless, the $211bn in outstanding HELOC debt is a riskier proposition than mortgage debt, mainly because people will do anything to make their mortgage payments and avoid defaults. The same cannot be said for HELOCs.
HELOC debt is worthy of increased scrutiny after several years of being ignored by numerous households. “There's no doubt in my mind: there's going to be a domino effect,” Campbell warned.