About a month ago we started a major renovation in our home. We are finishing the basement to accommodate the urgent needs of our growing family and, aside from the phone line getting accidentally cut, construction has been pretty smooth. It is an expensive undertaking which we are partially funding through our home equity line of credit.
This type of loan, commonly known by its acronym HELOC, uses our house as collateral and allows us to borrow up to a pre-set amount. We have a plan to pay off our borrowings within the year. Without access to a HELOC, we would have had to use a more expensive unsecured line of credit or delay the desperately needed project. So my ears perked up when I heard the federal government's announcement regarding HELOCs earlier this week.
The government will no longer provide backing for these loans, requiring banks to assume the full risk of lending to consumers. While the news was somewhat overshadowed by the other changes to the mortgage rules, the shift in the treatment of HELOCs will also have an impact on many Canadian households.
Over the past decade, HELOCs have surged in popularity given their low interest rates and easy accessibility. In fact, their growth has been double that of mortgage debt. Many Canadians, like me, turn to HELOCs to pay for home renovations that will build equity in their homes. Some have HELOCs in place to use as an emergency fund should the need arise.
But many treat these credit lines like a bottomless trough to feed their consumer whims and desires. It is the behaviour of these high-risk borrowers that the government is trying to muzzle. Now we can expect banks to become more discriminating when it comes to doling out this cheap cash. And those households that like to max out their HELOCs on dream vacations and luxury goods are in for a reality check.
Tina Tehranchian, a certified financial planner with Assante Capital Management, says that home equity lines of credit are meant to be used as a safety net or as a source of cash that you can pay back within a reasonable timeframe. "Unfortunately, for people with less discipline, their homes have acted as their piggy bank and you tend to see some people tap into their HELOCs for consumer related spending without having that expectation of being able to pay it down anytime soon."
She believes that the government's new position on HELOCs will help curb chronic debt offenders. "Some people who have been overstretched with high-interest credit card debt are rolling their debt into their HELOCs," she says. "For normal people that just use it as a backup, the change won't really affect them."
Ms. Tehranchian also cautions that those who have leveraged their home equity to buy investment properties may have less flexibility to do so in the future. "They may not be able to tap into their HELOCs for their down payment," she says. "It should not, as long as they have good cash flow, affect them otherwise. It will give the government an orderly cool down of the housing market."
Among my friends, many of whom have used HELOCs, there is little sympathy for those who have abused these loans through chronic consumer spending.
"I have less issue with the banks taking the risk and properly evaluating them than the government footing the bill if the banks are too lenient," says one.
Opines another: "I have used HELOCs to great economic advantage over the past 10 years, but they are not for everyone, nor should they be."
One friend was disturbed by the aggressive way his bank offered him a HELOC in the past, even though he did not need it. "Part of it was, 'Well, if you ever need a new roof, or a major repair, it's good to have ready access to funds,' " he says. "I get this pitch, but it's when they start talking about being able to buy cars or lifestyle purchases … the disconnect begins for me. It makes borrowing too easy and makes us take less responsibility for our purchase decisions."
The government's announcement may very well change the way banks as well as consumers treat home equity-based loans. For those who have become used to consolidating expensive credit card debt into HELOCs, it's time to heed Ms. Tehranchian's advice: "They should get their debt under control and pay down as much debt as possible."
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