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Debt Shift

120094316Credit cards account for just 5% of total household debt (Source: BoC), but it may not stay that low for long.

The government is on a mission to clamp down on low-cost secured borrowing (e.g., HELOCs).

If coming regulation makes it harder to access low-interest credit, borrowing will (not surprisingly) shift to high-interest credit.

The big winners in that scenario will be credit providers, not credit users.

As CMT wrote on March 20, OSFI is contemplating a reduction in the maximum loan-to-value of HELOCs, from 80% to 65% LTV.

If OSFI interprets this as meaning that one’s mortgage plus one’s HELOC (combined) cannot exceed 65% LTV, then tens of thousands of Canadians will turn to more expensive unsecured credit.

Hopefully OSFI:

a) realizes that LOCs are often integrated with mortgages, and

b) allows mortgages and LOCs combined to total 80% LTV, subject to some reasonable cap on the LOC portion(s) if deemed necessary.

Depending on the survey (CBA/Strategic Counsel or StatsCan), roughly 35-40% of Canadians carry a balance on their credit card(s). As interest rates and debt ratios climb, the number of people holding balances will also climb.

Overly restrictive credit line limits could force folks to maintain those balances at blood-sucking interest rates over 21%, instead of a good HELOC rate like prime + 1/2%.


Mark-CarneyNone of this dismisses the seriousness of Canada’s growing debt balloon. Governor Carney is rightfully concerned, saying:

“What we have seen in aggregate across the Canadian economy has been a sharp increase in the usage of home equity lines of credit, some of which have taken place in a context of underwriting standards that are less than optimal…Canadian households as a whole are being overstretched, which creates risk for the economy.”

This siren has Canada’s credit police eager to propose solutions. Unfortunately, the solutions proposed thus far could raise borrowing costs and stretch many households even further.

Incidentally, Carney did not define “less than optimal” when he spoke of HELOC underwriting the other day. It would have been nice if he had because many observers will challenge his underwriting statements. HELOCs have traditionally been low-risk products that are:

  • Uninsured
    • i.e., the lender assumes almost all the risk, not the government
  • Generally amortizing
    • e.g., Data from RBC, one of the biggest HELOC purveyors, shows that only 7% of customers make interest-only payments
  • Not over-utilized
    • Just 1 in 5 homeowners have a HELOC (CAAMP)
    • Median HELOC utilization (balance vs. limit) is 43% (Source)
    • The average HELOC balance is $60,000-$63,000, representing 18-19% of people’s home value (CAAMP). Much of that is mortgage-substitute, renovation or investment borrowing.
    • Only 3.9% of HELOC borrowers are maxed out and 30% have a zero balance (Source)
  • Secured
    • HELOC holders must have a minimum of 20% equity. Most have a fair bit more.
  • Sound
    • Default rates are well under 1%, despite record high debt-to-income levels.

104699417New HELOC guidelines, depending on how they’re enacted, threaten to shift debt from comparatively benign HELOCs to budget-busting high-interest cards and loans.

Some believe that this financial pain will serve as an effective deterrent to debt accumulation. We don’t.

People compelled to borrow will keep borrowing. Heavy debt users are often compulsive spenders or event-driven spenders (i.e., unexpectedly forced to borrow due to divorce, illness, job loss, etc.).

When these folks try to get back on their feet and reform their finances, many could find that new government policies block their access to low-cost credit, thus extending their debt payoff period by several years.

If that scenario materializes, this decade could include some of the most profitable years ever for credit card issuers.

Sidebar: Home-equity extraction has funded roughly 3 per cent of aggregate consumer spending in Canada in recent years, the Bank of Canada says.

Partial Sources: Reuters, StatsCan

Rob McLister, CMT