The Rise & Demise of the HELOC

Steve Saretsky -

A recent report from the FCAC (Financial Consumer Agency of Canada) shed some light on Canadian households, in particular their desire to tap home equity, which has showered Canadians with cheap credit amidst a two decade long housing boom.

As of today, just over 3 million Canadians have tapped a Home Equity Line of Credit (HELOC), with outstanding balances jumping to over $200B. For further context, HELOC balances in Canada have gotten so large they now make up just under 13% of GDP, far surpassing our neighbours to the south when HELOC balances reached 4.5% leading up to the financial crisis.

Similar to our US counterparts, our spending behaviours are nearly identical. Per the FCAC report, 49% of HELOC borrowers used the money to pay for renovations. This is strikingly similar to a US federal Reserve study which found 43% of funds pulled out of home equity are used for home improvements.

Canadian HELOC borrowers

As I had written previously, Canadians are frequently using Home Equity Lines of Credit to facilitate the purchase of second properties. The largest median amounts of HELOC loans were used for residential properties ($59,800). This was followed by vehicle purchases, which up until recently had experienced an unprecedented boom, with new car purchases hitting a record high in 2017.

The growth in home prices and the rise of home equity lines of credit play a self full-filling role within the economy. Higher home prices have fuelled a rising wealth effect, propelling consumer spending. But Alas, this wealth effect is equally prone to the downside as home prices reverse. The average home price across Canada dropped 4% in 2018, the first annual decline since 2008.

Studies in the US illustrate the lowest-credit home owner borrowed $0.40 for every $1 of new home equity but as the bubble deflated households reduced spending by six cents for every $1 of home equity that was lost.

In Canada with home prices sliding and interest rates rising, this will pose financial stress across many households. One-quarter (25%) of HELOC borrowers say they would struggle to make payments on their HELOC if the payment amount increased by $99 or less per month. And with the further stress testing of home equity lines of credit the ability to roll over or refinance existing debt could become increasingly difficult.

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The Saretsky Report. December 2022