Feeling The Hell In 'HELOC'

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Includes: EWC, FCAN, FLCA, HEWC, IFNA, QCAN
by: Danielle Park, CFA

Last night at our community gym the local radio station blared recurring ads for 'easy refinancing' and 'easy home loans'. 'Take that trip… redo that kitchen… consolidate those debts… help the kids!' The jingles were relentless and the message clear: "Why wait until you have the money, to spend it on those things you always wanted!"

This reminded me of how over the past decade, Canadian banks have increasingly recommended that customers agree to a collateral charge on their homes when they apply for a mortgage. Lenders like TD Bank (NYSE:TD) have even been encouraging people to register collateral loan limits that are 125% of a home's current market value (typical sales team genius).

Unlike a standard charge with defined payments of principle and interest, for a fixed term, that reduce the debt towards zero over time, most collateral charges are re-advanceable. As principle re-payments are made and/or property values increase, the room to borrow magically grows larger by the week. In other words, collateral charges offer the potential for never-ending debt obligations. Great for lender profits - at least until the write-offs inevitably follow; but worse for the borrowers - nearly always.

Then there was the Globe and Mail feature last Saturday Home truths: Easy equity is trapping us in record debt that profiled real life Canadian families and the never-healing-debt-wounds that plague them as they stretch for unaffordable homes and lifestyle with self-destructive amounts of credit. Now they are feeling the hell in collateral mortgages or 'HELOCs' (home equity lines of credit). Here are a few stats:

In 2017 alone, customers of Canada's six largest banks borrowed $14.4-billion more on their HELOCs than they repaid, pushing such borrowing to a record $207-billion as of Oct. 31 - up 7.5 per cent from a year earlier, according to a Globe and Mail analysis of the banks' financial reports…

Spurred by soaring house values, HELOCs - which allow people to borrow against the equity they have in their homes - have become the key household credit source for Canadians, now accounting for 40 per cent of all non-mortgage consumer debt, according to a 2017 report by the Financial Consumer Agency of Canada. Credit cards, by comparison, represent about 15 per cent of non-mortgage debt.

…Homeowners are using home-equity lines of credit for an expanding variety of purposes, making the low-interest borrowing lines the primary financing source for everything from vacations to stock market investing.

An online survey of 1,521 readers conducted by The Globe and Mail in early March found that most HELOC borrowers now use them for multiple purposes, going far beyond their traditional use for home renovations… 23 per cent of people with an outstanding balance said they used their line of credit for living expenses, including bills, vacations and education costs. Seven per cent said they used their HELOC to buy a vehicle, and 16 per cent said they used it to pay off or consolidate other debts, including credit cards, which typically have far higher interest rates.

The predictable result is households (an economy and tax base) that are financially fragile: vulnerable to shocks from income and job loss, rising rates, stagnate and falling home prices, health problems, marital strife, aging, and less savings for other critical areas like emergencies, education, business investment and retirement.

With rates rising, home prices falling, and 78% of Canadian mortgages up for renewal in the next 3 years - 47% in 2018 alone - we have now entered the pay-for-recklessness-phase of the credit cycle in Canada. An early warning indicator, the percentage of credit card users who "roll" from early stage delinquencies to 60-89 day delinquencies - recently reached the highest levels since 2008. See this from yesterday: Cracks 'Starting to show' in Canadian credit quality, RBC says.

No, Scotiabank, the masses aren't 'richer than they think'. They are broke, and this madness will cost us all plenty in the end.

Disclosure: No positions