With the Bank of Canada set to raise lending rates, mortgage holders have been warned to expect more expensive debt than they've become used to. But other forms of debt are even more vulnerable to the tiny rate hikes to come.
Traders are about 90 per cent certain of a rate hike at 10 a.m. ET Wednesday, with the bank's benchmark rate expected to inch up to 0.75 per cent from 0.50 per cent. And a major impact of that move is likely to be felt entirely outside the mortgage market.
In recent years, home equity lines of credit — or HELOCS — have become popular among homeowners eager to turn their eye-popping house price gains into usable cash.
In a HELOC, a lender allows a borrower to withdraw a certain amount of money against the equity in their home. The interest rates tend to vary between 0.5 and two points above prime, so they're a little more expensive than mortgages.
But consumers love them for the convenience. Many allow borrowers to simply make payments against the interest with no obligation to pay down the principal each month.
They're not a tiny slice of the market, either. There are about three million active HELOCs across Canada, with an average balance of about $70,000, the Financial Consumer Agency of Canada warned last month.
Home like an ATM
"When used responsibly," the consumer watchdog said, HELOCs "can provide many benefits to consumers such as low interest rates, convenient access to funds and flexible repayment terms."
- DON PITTIS: What were investors thinking?
Homeowners with pumped up equity in their homes love them, Laurie Campbell of credit counselling agency Credit Canada says, because they let them access some of those gains without having to move.
"A generation ago, you'd get a mortgage and pay it off," she said in an interview. "Now you get a HELOC and treat your home like an ATM."
Many have been. Almost 40 per cent of people who have them make no regular payments against the principal, FCAC says, which makes them vulnerable as rates rise.
"It's a hidden problem," Campbell says, "because with rising house prices many people took out HELOCs with no intention of paying them off. So today, they owe as much on them as they did three or four years ago."
Can be called in at any time
Most are set at variable rates. So they're likely headed up in lockstep with any looming central bank rate hikes, and most have no limitations on how fast they can rise beyond that without warning.
They're also so-called "demand loans" — meaning unlike a mortgage where as long as you make payments you're fine, the lender can call them in at any point and insist on paying back the full amount.
With uncertainty growing around housing prices, lenders will be unlikely to call in those loans and start a panic. But the $211 billion in outstanding HELOC debt is a riskier proposition than growing mortgage loads, Campbell says, mainly because people will do anything to make their house payment and avoid default. The same can't be said for HELOCS.
Many HELOC owners justify them by taking the funds to reinvest them into their houses via renovations. But that, too, only exacerbates the danger in an era of higher rates and possibly lower house values.
Real estate analyst and author Alex Avery says many homeowners convince themselves that taking out $20,000 to pay for a new kitchen is money well spent because they've been given bad advice.
"One of the drivers behind that," he told the CBC recently "is they believe it's an investment."
Realtors and others in the real estate industry often tell owners that the best way to improve the value of a home is a kitchen or bathroom renovation.
"That's very biased advice," Avery says. "It does happen to correlate with the two most expensive rooms in your house."
So whether the money went to fix up the home, go on a vacation, or something else, HELOC debt is worthy of increased scrutiny after several years of being ignored.
"There's no doubt in my mind," Campbell says, "there's going to be a domino effect."