In recent years, home equity lines of credit — or HELOCs — have become popular for homeowners that want to turn their huge house price gains into cash.
In a HELOC, a lender allows a borrower to withdraw a certain amount of money against the equity in their home. The interest rates tend to vary between 0.5 and two points above prime, so they're a little more expensive than mortgages.
And they are extremely convenient. While people will do anything to make their monthly house payment and avoid default, HELOCs allow borrowers to simply make payments against the interest with no obligation to pay down the principal each month. Most people had no real intention to pay them off, and most felt safe about taking a loan in the face of rising home values. Almost 40 per cent of people who have them did not make regular payments against the principal. They owe the same amount on the principal as they did four or five years ago.
A generation ago, the common wisdom was to pay off your mortgage. Now people are using their homes like an ATM. That’s a big shift in financial thinking, and it may not serve them as well with the looming economic realities.
HELOCs are not a small share of the market either! Currently, there are over three million active HELOCs across Canada, with an average balance of about $70,000.
Statistics Canada 2011 reported 13,320,610 homes, meaning 23 per cent of homes are using HELOCs with an average balance of $70,000 per home. That’s 211 billion dollars in loans.
The downsides of HELOCs:
Before you consider taking one, be aware of three facts:
They can be called in at any time. They are "demand loans" which means, unlike a mortgage, the lender can call them in at any point and insist on paying back the full amount.
Most are set at variable rates and are in lockstep with central bank rate hikes. Your interest payments are going to increase.
Most have no limitations on how fast they can rise beyond that with no warning.
We’re not saying you shouldn’t get one. After all, lenders will be unlikely to call in those loans and start a panic. But, don’t let low monthly payments lull you into forgetting this is a loan, and the $211 billion in outstanding HELOC debt is a greater risk to the Canadian economy than mortgages ever were.