Consumers turning to home equity loans

Sarah Staples, Postmedia News · Mar. 30, 2011

When Sean Fitzgibbons needed a short-term loan last year to cover his daughter's first year of university, his wife's master's degree and a bathroom renovation, the real estate industry veteran knew exactly what to do.

Mr. Fitzgibbons took out a bank-structured home equity line of credit, or HELOC, a form of financing that's zoomed in popularity in the last decade.

"We wanted to protect ourselves, to make sure we had good cash flow, and we knew based on experience that an option would be to dip into equity in our home," says Mr. Fitzgibbons, a former real estate agent who runs the Toronto office of Multivista Construction Documentation Inc., which photographs home renovation and commercial construction sites.

But is a HELOC the right option for this borrower, and for thousands of Canadians who have turned it into one of the trendiest instruments of personal finance?

The volume of HELOCs has ballooned by up to 170% in 10 years, nearly double the speed of mortgage debt, according to the Bank of Canada.

Critics say HELOCs, which account for 12% of overall household debt, make it easier for Canadians to borrow too heavily against their homes. They're non-amortizing, so borrowers can opt to pay interest on whatever is drawn down, not the principal, which arguably imposes less discipline than a mortgage with fixed repayment terms for interest and principal.

And since a HELOC is almost always a variable interest rate product pegged to the Bank of Canada's prime, if interest rates rise too quickly, a borrower might not be able to keep pace.

The government recently tightened mortgage rules: changes that took effect March 18 allow borrowers to secure up to 85% of their home's assessed value through a refinancing, down from 90% previously (HELOCs are only available to a maximum of 80% loanto-value). Loans may be made on a 30-year amortization -or repayment -schedule, instead of 35 years. And effective April 18, the Canada Mortgage and Housing Corporation will no longer offer mortgage insurance for non-amortizing loans such as HELOCs.

But the mortgage industry says HELOCs aren't proven to be the culprit behind rising consumer debt. And if used judiciously, they're a low-cost financing option for Canadians who might otherwise rack up expensive credit card debt to cover urgent needs.

"The biggest downside is definitely the temptation to use the money because it's there," says Marcel Ghazouli, a mortgage broker with Premiere Mortgage Centre of Mississauga, Ont. "The advantage is, it's money there when you need it."

HELOCs provide revolving credit: once approved, they can be continually repaid, without penalty, and the credit drawn down again and again.

There's no obligation to re-qualify for assistance, for example, following a sudden drop in the family's income, since the loan is secured against the home.

Canadians typically play it safe with such financing, says Jim Murphy, president and chief executive of the Canadian Association of Accredited Mortgage Professionals.

A study by his association last fall revealed one in five Canadians withdrew equity from their home in 2010, averaging $46,000 per borrower; of those, 45% used the money to consolidate and repay higher-interest debt, 43% made home improvements, and 19% paid for education.

According to Mr. Murphy, it's "too early to say" if the federal rule changes will dampen enthusiasm for HELOCs.

"The basic result is you can borrow less on your home than you could have," he concludes, "but you can still borrow a lot on the value of your home."

Repaying fully within two to five years should be the goal, Mr. Ghazouli says.

HELOCs are especially useful for funding renovations to improve a home's resale value - better still, if the home is to be listed for sale soon afterward, and proceeds will be used to pay off the loan, he says.

Taking advantage of the current real estate market in Toronto, Mr. Fitzgibbons was able to maximize the amount of his credit line at historically low interest rates.

Similar to selecting a contractor, he put several mortgage companies through the paces, getting references and ultimately choosing a reputable broker to guide him through the array of HELOC products on offer.

"People will go into a bank and say, 'I need a line of credit or a credit card,' the bank will say OK," Mr. Fitzgibbons says.

"But if you've done your homework and know what to ask for, and you have a broker who's on it every day, you'll get better advice."