TORONTO -- Home-equity loans have become a fast-growing source of cheap borrowing for Canadians -- so alluring that some have treated their homes as a personal bank machine and put off thinking about the debt that must be repaid.
Many Canadians have turned to their homes as a source of cash for everything from renovations or vacation to debt consolidation or RRSP investments, which they can achieve at a much lower interest rate than credit cards or unsecured loans because their home is used as collateral.
But with mortgage rates expected to rise and home prices to fall, experts say now is the time for those who have piled on debt while decreasing their home-ownership stakes to start building up equity.
Home-equity lines of credit, known in the industry as HELOCs, are the fastest-growing source of credit in Canada. The Bank of Canada estimates the dollar amount of HELOCs has risen by as much as 170 per cent in the past decade or almost twice as fast as mortgage debt.
However, many Canadians are unaware of the implications of this cheap borrowing. Nearly 60 per cent of respondents in a recent poll for TitlePlus insurance did not know taking out a HELOC amounts to a mortgage or a second mortgage (if they already have one).
The trend has left Canadians with an average 34 per cent of equity in their home, the lowest level in two decades and a 20 per cent drop in four years.
The Bank of Canada has recently pointed out much of the increase in household debt to a record 153 per cent of income is not due to mortgages, but rather loans secured by home equity Canadians in turn spent on consumer items and renovating their homes.
"We've seen it as a growing problem, first with debt consolidation and now more often with renovations and things like that," said Patricia White, executive director of Credit Counselling Canada.
White said she's talked to clients who have taken on a HELOC to consolidate their debt, then find themselves in debt again and no longer have any room to manoeuvre because they can't use their small remaining stake in their homes as leverage.
Home equity lines of credit allow you to access up to 80 per cent of the appraised or purchase price of your home (whichever is lower) less any outstanding mortgage or other charges. The more equity you have in your home, the more credit becomes available -- but the more you use, the less equity you have in your home.
They're usually calculated based on the prime rate and you can get a secured line of credit for as little as half a point above that rate. Your interest rates will change if the prime rate does -- and sometimes even if it doesn't, as lenders can raise the interest rates they charge on top of prime arbitrarily.
The plans are extremely flexible and allow you to pay as little each month as interest only, or as much as you want. The problem is some homeowners choose to pay just the minimum, which only covers interest -- leaving a huge mortgage on their homes.
Cheap borrowing rates introduced since the recent recession have helped Canadians to get deeper into personal debt, said Lior Hershkovitch, a mortgage agent in the Toronto area.
The most recent downturn marked the first time Canadians came out of a recession with more debt than they had going in, he noted.
"But it would be very wise for them to take advantage of (low interest rates) and pay it down as much as they can while rates are low."
Those who find themselves in debt with declining equity in their homes need to put the brakes on drawing from their HELOC, even if there is still room on it.
Don't borrow over half your limit unless for an emergency. And if you use your HELOC for discretionary spending, don't fall into the trap of interest-only payments, said Rob McLister, editor of the Canadian Mortgage Trends blog.
"If your balance is large, pay at least four to five per cent of your balance each month. If you can't afford four per cent payments, don't borrow further until you can," he advises.
Start by calculating how much you can realistically increase the amount you pay every month. If that extra amount would be difficult to reach while still making ends meet, it's a sign you're overextended and may need to seek a professional to help create a plan.
It's important to take such steps now because the share of household income going toward paying off debt will increase when borrowing costs return to more normal levels as economic conditions improve.
-- The Canadian Press
Some pros and cons of home equity lines of credit, according to Robert McLister, editor of the Canadian Mortgage Trends blog.
Pros of a HELOC:
-- A low-cost source of liquidity you can tap repeatedly without reapplying.
-- At 3.50 per cent, HELOCs are typically the cheapest rate for an open readvanceable loan today ("open" meaning it can be paid off in full any time without a penalty).
-- HELOCs are a viable alternative to an emergency fund because they don't force you to keep your contingency savings in low-yielding investments. You can instead park your free cash in investments that earn more than a few per cent.
-- HELOCs offer the lowest possible payment and flexible payment schemes, including an interest-only option.
-- Some HELOCs offer interest offsetting by linking to a chequing account.
-- It's easy to borrow more than you initially intended.
-- It's much harder to switch a HELOC to another lender without paying legal fees. By contrast, lenders normally pay your legal fees when you switch over a regular mortgage. Exceptions exist, of course.
-- HELOC rates are not fixed. They can always be arbitrarily increased by the lender, even if prime rate doesn't change.
-- Lenders can always reduce your HELOC borrowing limit for any reason, even if you have a perfect repayment history. This happens sometimes when you carry a large balance and continually rack up debt and/or make only small payments. It may happen more if home prices start falling or unemployment starts rising notably.
-- Title insurance fees can be higher on a HELOC than on a regular mortgage.
-- HELOCs are more difficult to transfer to a new property. It's common to have to discharge,or pay them off completely.
-- There can be a negative effect on your credit score if you borrow a large percentage of your approved HELOC limit -- even if you're merely using your HELOC like a mortgage.