Interest-only payments and other reasons HELOCs are a ticking time bomb

By: Lisa Coxon on January 16, 2019

Home equity lines of credit are now the single largest contributor to non-mortgage consumer debt, but according to an online survey released by the Financial Consumer Agency of Canada (FCAC) on Tuesday, a striking number of Canadians don’t fully understand how they work.

FCAC surveyed 4,800 Canadians to find out what they know and don’t know about HELOCs, and collect behavioural data on how people are using them.

Most respondents scored less than 50% on their knowledge of HELOC terms and conditions. And 25% of Canadians are only paying interest on these loans, yet 62% of those borrowers were “overly optimistic” about repaying their HELOC in full within five years.

More than any other age groups, 25 to 34-year-olds said they made interest-only payments on their HELOC; often used their HELOC to meet payments on other debts; and would struggle if their payment increased by $100 per month.

Michael Toope, communications strategist for FCAC, told CBC News that this checks out. Generally, younger people are earning lower incomes and might still be paying off student debt as well as a mortgage.

But it’s still concerning, considering respondents demonstrated low levels of knowledge about the fact that banks can raise the interest rate of a HELOC at any time, ask that it be repaid in full at any time, as well as raise or lower the credit limit whenever they like.

"People should know what they are going to use it for and how to pay it down, so it doesn't become an eternal revolving debt," Toope said.

More than three million Canadians have a HELOC, owing an average amount of $65,000. Last September, B.C. homeowners had the biggest HELOCs in Canada, at an average balance of $124,000.

HELOCs now rank second to mortgages as the largest source of growing household debt, according to FCAC. They function as revolving lines of credit that allow homeowners to borrow against the current market value of their home, are traditionally lent at a much lower interest rate than other lines of credit, and are secured by the home.

Roughly one-third (35%) of all survey respondents who owned a home, condo, or co-op had a HELOC. And the main uses of these lines of credit were renovations, debt consolidation, vehicle purchases and daily expenses. While most respondents used their HELOCs as initially planned, 19% borrowed more than they expected to.

“Borrowers would benefit from more upfront information about HELOCs and should take steps to learn about them,” FCAC’s report states. “Repayment plans that include making regular principal payments can help HELOC borrowers mitigate the risks of over-borrowing, debt persistence, and wealth erosion.”

HELOC owners face much stricter rules if they want to apply for a new mortgage, too. In a stealthy move by some of the country’s largest lenders last year, banks now require proof that HELOC owners applying for additional financing, like a mortgage, can afford a repayment based on their entire HELOC credit limit, regardless of whether or not it’s been used, as opposed to the balance currently owing on the HELOC.