The Bank of Canada is asking lenders to provide more detailed information on Home Equity Lines of Credit (HELOCs) so it can conduct a proper assessment of just how risky they are to Canada’s financial system.
“Given the flexibility HELOCs can provide, borrowers can use them even in a downturn or if they lost their jobs to sustain household spending and continue to service their other debt,” Robert Colangelo at credit rating company DBRS Ltd. told BNN Bloomberg.
“It makes it difficult for lenders to identify emerging credit problems.’”
Lenders will be formally required to provide reporting of HELOCs on May 15. They’ll need to share information such as “utilization rate, or the share of drawn amounts versus approved amounts,” according to BNN.
Part of the concern stems from the fact that the BoC doesn’t actually have a clear picture of how much Canadians owe against their homes.
The other concern is that HELOCs are changing. Traditional HELOCs allow homeowners to borrow up to 65% of the equity in their home. They act as secured revolving lines of credit and generally come with relatively low interest rates and flexible repayment schedules that typically only require interest to be paid each month.
But then there’s something called a hybrid HELOC, which is a HELOC and a mortgage combined. Himanshu Bakshi, credit research analyst at Bloomberg Intelligence in New York, told BNN Bloomberg that hybrid HELOCs are generally considered less risky since they’re partly amortized. They enable homeowners to borrow as much as 80% of their home’s value: 65% of that is the HELOC, on a revolving basis, and 15% of that is done, like a mortgage, on an amortization schedule, with regular payments of principal and interest.
Not surprisingly, HELOCs can significantly add to household debt. In fact, they’re now the single largest contributor to non-mortgage household debt, according to the Financial Consumer Agency of Canada (FCAC), which recently launched an ad campaign warning consumers of the risks of HELOCs.
This FCAC ad, for instance, can be spotted on various TTC subway platforms (we took this at Davisville station in Toronto):
HELOCs have also made it much harder to apply for a new mortgage, since homeowners now have to prove to lenders that they can afford to repay not just the balance owing on their HELOC, but their entire HELOC credit limit, even if they haven’t used it.
But perhaps the most trepidatious scenario is if home prices fall and borrowers wind up with more debt than their home is actually worth. This is called “negative equity” and it’s very concerning for the stability of the housing market. That’s because in other housing markets where owners have fallen into negative equity — as was seen in many U.S. cities during the 2007 housing crash — owners tend to just walk away from their homes and default on their mortgages when that happens.
According to BNN Bloomberg, as of January 31, the Big Six Banks “reported $223 billion of outstanding, or drawn, HELOCs.”
This, BNN says, represents about one tenth of Canada’s total household debt.