The irresistible

Will the federal budget blow up HELOCs? What a surprise that would be to three million little debt-snorfling voters.

Big fanfare this week for a new report by a federal agency that frets over people’s finances. Needless to say, they have a lot to worry about. Most of us are basket cases when it comes to money. Almost half couldn’t survive missing just a paycheque or two. Nine in ten haven’t maxed their TFSAs. Family debt tops $2 trillion – bigger than the entire economy. Mortgage loans shot higher last year even though house prices went down. Quelle mess.

Home equity lines of credit have been the hottest banking product of the last decade. No wonder. People have stored most of their net worth in a single asset – their houses. So far we’ve borrowed more than $300 billion against residential real estate, half of it spent on the same properties, to finance renos. This doubling down is insane, of course, when home values have peaked and interest rates are rising. But, there ya go. More for Ottawa to worry about.

The new report confirmed what this blog reported last year – a quarter of all the HELOCers are paying nothing on their loans. Only interest. And most of them are using the lines themselves to get the interest money itself – so the debt keeps expanding until it hits the limit. The feds also found half of Canadians have no clear idea how these lines work or the risks involved.

And, yes, the dangers are real.

HELOCs are demand loans. The bank can call you any day of the week and demand the thing be repaid. If real estate crashes or your financial situation hits the skids, that phone call is not so unlikely. And home lines of credit are almost always variable – so every time the Bank of Canada raises its benchmark rate, your borrowing cost goes up. (There are two more increases expected in 2019.) Lenders can also decrease your line’s limit arbitrarily – which sucks since a third of all borrowers say they often or always use HELOC money to make other debt payments.

So every year more people with houses borrow against them, and the HELOC balloon grows. Currently about $100 billion is not being paid off – at all. Meanwhile the cost of carrying all this debt has increased substantially over the last year, in which the central bank jacked rates three times. Home equity lines have turned into quasi-mortgages, a form of debt which will typically last decades or maybe forever – draining off cash flow and eroding real estate equity.

So why do people do this?

Simple. HELOCs are like me – seductive and irresistible, but dangerous when abused. They’re also cheap – prime plus a half for most borrowers. Banks dole them out like lollipops – up to 65% of the equity in a home can be borrowed. They’re open – no term – and can be borrowed against or paid off at any time without penalty. And if you use the money to invest, the interest may be deducted from taxable income. But, sadly, since three-quarters of folks take the money for renos or debt payments, they entirely miss this benefit. Once again, financial illiteracy on full display. No wonder most people live on the edge. By the way, Ottawa’s survey also revealed those aged 25-34 would seriously struggle if their monthly payment increased by just a hundred bucks.

Bankers have been routinely offering people equity-based lines when they take out mortgages. Yep, debt and more debt. Plus there are financial products increasing the limit on a HELOC as the principal on a mortgage is reduced. So overall indebtedness never really falls – you just swap a fixed-rate, stable borrowing for a demand, variable-rate one. No wonder Bay Street loves this stuff.

Was this report, coming just weeks before the next federal (pre-election) budget, timed to set the stage for changes?

I hear it’s under consideration. The 65% equity-borrowing limit could become 50%, then reduced further in subsequent years. Plus, interest-only payments could be banned, with a requirement for banks to adopt blended payments, as with mortgages. Such changes would be prudent and in the public interest. But they’d obviously shock more than a million people who pay nothing against their loans and steadily increase their level of poochedness.

Your neighbours, in turning their homes into banking machines, have created a $300-billion bomb. Ottawa, for its part, has turned a blind eye. Do you think politicians will now do the right thing?

Me neither.