If you owned a home with a mortgage five years ago and still do, odds are you've seen your home equity explode.
Based on mortgage balances at the time and price gains since, urban homeowners have seen roughly 65 percent increases in their equity on average, in just 60 months.*
Rising equity empowers countless homeowners to borrow more from their homes—if they so choose, and if they qualify. And recent data from the Office of the Superintendent of Financial Institutions (OSFI) suggests they're doing that more and more, using Home Equity Lines of Credit (HELOCs).
The latest data shows that Canadians have leveraged their homes to take out more than $301 billion in real-estate secured loans (mainly HELOCs), according to Better Dwelling. That's up 26 percent in just 5 years.
It's not hard to see just how important rising home values are to debt-reliant homeowners. Were home prices to crash, not only would equity available for borrowing wither, but lenders would tighten up on HELOC lending considerably to lessen their risk.
Increasing Reliance on Home Equity
In January, the Financial Consumer Agency of Canada (FCAC) sounded alarm bells over how Canadians were using HELOCs.
It reported that a worrisome 27 percent of Canadians with HELOCs were typically making only the minimum required interest payments (no principal) on their outstanding balances. That rises to 41 percent for 25-34-year-olds.
The FCAC also found increasing numbers of people using HELOCs as a lifeline—i.e., essentially using debt to pay debt. A sizable 30 percent of HELOC holders were using home equity to pay credit cards, mortgage payments or other loans. For homeowners aged 25-34 the number was 36 percent, reinforcing that young Canadians are even more dependent on debt.
Sidebar: What we'd like to know (and what policymakers should monitor) is the percentage of people using their HELOCs to pay their HELOC interest. A surge in that number could be worrisome. At some point, credit limits run out. In a recession, it's even possible that banks could freeze borrowing for less creditworthy homeowners with persistently growing HELOC balances and no principal paydown. Unfortunately, reliable stats on people using HELOCs to pay their HELOC are hard to find.
Fuelling HELOC usage is the unmistakable trend of readvanceable mortgages—i.e., mortgages combined with a HELOC. Banks love selling these products (as they're much more profitable) and consumers love getting them (because of their borrowing flexibility). With 6.7 percent annual growth, readvanceable mortgages are one of the fastest growing products in the residential credit market.
Uses for Home Equity Withdrawals
"HELOCS can be risky...," FCAC warns, citing the dangers of chronically growing debt balances. Thankfully, most people with HELOCs have ample and growing equity.
Those with mortgages and HELOCs had 58 percent equity on average as of last year. Those with standalone HELOCs had an 80 percent equity.
And not all HELOC holders are using their home equity frivolously, per se. Data from the FCAC shows Canada's 2.1 million HELOC holders used their home equity in the following ways:
- Renovations: 49 percent
- Debt consolidation: 22 percent
- Vehicle purchase: 19 percent
- Day-to-day expenses: 19 percent
- Emergency funds: 14 percent
- Vacation/travel: 13 percent
- Residential property purchase: 11 percent
- Financial investments: 11 percent
While reliance on HELOCs for everyday expenses, vacations and other "bad debt" uses is a problem, most HELOC borrowing creates value or lowers interest expenses. So long as the number of homeowners who rely on HELOCs to live (or habitually refinance bad debt into them) doesn't grow substantially, secured credit lines will continue serving a net benefit to Canada's economy.
* Based on CREA average home prices, natural mortgage amortization and percentages of equity in 2014, as reported by Mortgage Professionals Canada.