Canadians borrowed an additional $2 billion on home equity lines of credit (HELOCs) in February 2022 – the biggest one-month increase since 2012.

Canadians rely on home equity lines of credit as rates rise

As HELOCs are generally based on a variable interest rate, borrowers can expect a corresponding increase in required payments.

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Despite expectations that the Bank of Canada was set to raise interest rates this year, a 10-year record was broken when Canadians borrowed an additional $2 billion on home equity lines of credit (HELOC) in February 2022 – the largest one-month increase since 2012.

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Before discussing the ramifications of this, let’s back up a bit and explain what a HELOC is and how it works. A HELOC is a line of credit secured on your home. It’s like a second mortgage that, once in place, costs you nothing if you don’t use it. Once eligible, a homeowner can borrow up to 80% of the value of their property, including any outstanding mortgages currently in place.

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For example, if your home is worth $500,000 and you currently owe $300,000, the remaining equity you could access through a HELOC is $100,000 ($500,000 x 80% minus the mortgage of 300 $000). If a homeowner doesn’t have a mortgage, the maximum HELOC amount is 65% of the home’s value.

The advantage of HELOCs is that a homeowner can access their equity at any time, without having to repeatedly apply for financing for vehicles, home repairs, and vacations. Payments are low, based on an interest-only amount, but just like a credit card, it’s also a form of revolving credit. This means that these lines of credit carry the risk of never being fully repaid.

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HELOCs are also usually variable interest rate, which means they are subject to interest rate fluctuations. It’s not a bad thing when rates go down. But that can be a risky commodity in our current economic climate. Every time interest rates increase, the required payment on a HELOC will also increase.

Why then would so many Canadians choose to access their home equity during these uncertain times?

One reason could be that consumers are tapping into their new capital to consolidate other, higher-interest debt. It’s not a bad decision to transfer high-interest debt to a lower cost of borrowing, but it can put your home at risk if rates continue to rise and payments become unaffordable.

Some Canadians may also have found themselves owing the Canadian Emergency Response Benefit (CERB) repayment at tax time and decided that the best way to avoid the interest charged by the Canada Revenue Agency was to use their convenient, low-interest HELOCs to pay it off.

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Another possible cause could be that many homeowners are doing much-needed home renovations. There’s nothing like being stuck at home for two years during a pandemic to realize your home needs some upgrades.

As property values ​​have increased in recent years, the amount of equity that can be partially accessed through a HELOC has also increased. Having a flexible borrowing option like a HELOC means easy access to funds that can help improve your living space as well as the resale value of your home.

A HELOC can be a valuable borrowing tool as long as it is used correctly. However, access to on-demand credit can make it far too easy to spend beyond what we are able to repay. Even though using that credit for renovations can increase the overall value of your home, it doesn’t mean you can afford to pay off that extra amount of debt.

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How will the recent and impending interest rate hikes affect homeowners who already have debt on their HELOCs?

Since HELOCs are generally based on a variable interest rate, when the Bank of Canada raises its overnight rate, borrowers can expect a corresponding increase in required payments. Every $100,000 of HELOC debt owed results in a Additional $500 interest charged per year when interest rates increase by 0.5 percentage points.

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If interest rates increase another 1.5 percentage points this year, the result will be an annual increase of $1,500 in interest, on top of what you are already paying. For Canadian households struggling with the rising cost of living, this could be too much for their budget to handle.

To escape potential increases in variable interest rates, consider converting lines of credit to a fixed interest rate. Talk to your financial institution or mortgage lender about your options. Keep in mind that locking in will secure your interest rate, but the required payment amount will likely increase.

If a higher payment puts too much pressure on your budget, you may find it helpful to have a free financial review with a nonprofit credit counseling agency. A credit counselor can discuss ways to improve your household budget and free up space to pay off that unpaid debt.

Sandra Fry is a credit counselor in Winnipeg with the Credit Counseling Society, a not-for-profit organization that has been helping Canadians manage their debt for over 25 years.

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