Bank of Canada Staff Warn Home Equity May Be Concealing Financial Distress

Canadian real estate owners may be hiding financial vulnerability using complex debt products. Bank of Canada (BoC) staff published a new analytical note examining new home equity data. The new data gives more insights into home equity borrowing, and how the debt is drawn. Out are traditional HELOCs, held separately from the mortgage. In are mortgages combined with HELOC components, allowing owners to withdraw principal immediately.

Standardized HELOC Debt Reporting Has Arrived

OSFI has standardized the reporting of home equity line of credit (HELOC) reporting. The new reporting standard separates residential secured lending into traditional mortgages, stand-alone HELOCs, and mortgage-HELOCs. Breaking these segments down will allow a better understanding of home equity debt.

Most likely, you’re already familiar with the first-two segments of debt. The less familiar, but increasingly popular combined mortgage-HELOC is what might be new. Better known as readvanceable mortgages, they combine a fixed rate mortgage with a variable rate HELOC. The amount of HELOC credit extended automatically increases with payments against the mortgage. Borrowers can immediately replace traditional mortgage debt with new HELOC debt.

In exchange for the privilege, readvanceable borrowers pay more interest on their mortgage. Banks love these because they combine a higher rate, with perpetual debt. Great for the bank, not exactly a reason for households to celebrate. Let’s go over Canada’s new love for these more complex loans.

Canadian HELOC Growth Is Down Over 7%

The outstanding balance of stand-alone HELOC debt is dropping, according to filings. The balance has reached $63 billion in Q4 2018, down 7.6% from the year before. This represents 4.6% of the total of residential secured lending. Not exactly reflective of the trend most commonly reported by regulators. That doesn’t mean they aren’t using HELOC debt though. Instead, more home equity debt is being held in readvanceable mortgages.

Canadian Residential Secured Lending Q4 2018

A breakdown of secured residential lending held by OSFI regulated banks in Q4 2018. Numbers in percentage, and billions of Canadian dollars.

Source: Bank of Canada, Regulatory Filings, Better Dwelling.

Readvanceable Mortgage Growth Is Ripping Higher

The balance of combined mortgage-HELOCs, a.k.a. readvanceable mortgages, are growing faster than traditional mortgages. The outstanding balance reached $509 billion in Q4 2018, up 6.7% from last year. Breaking that down, the HELOC portion represents $110 billion of that debt, up 3.3% from last year. Contrast, traditional mortgages grew at just 2% from last year. More people are opting for a HELOC stuffed mortgage, and paying a little more for the privilege.

Canadian Residential Secured Lending Growth Q4 2018

The annual rate of growth for secured residential lending debt held by Canadian banks.

Source: Bank of Canada, Regulatory Filings, Better Dwelling.

If the issue isn’t clear, the BoC analysts spell it out for us. In the report they note, this could facilitate the accumulation of debt “at the expense of gaining equity in one’s home.” They further add it may be “concealing emerging financial distress if borrowers are taking equity out of their homes to manage other debt obligations or to finance their daily expenses because they lack other sources of funds.”

More interest paid and less equity accumulated means more vulnerability. BoC analysts conclude close monitoring is warranted as “debt secured by housing may find themselves with minimal (or even negative) housing equity if the value of their house falls.” New data points, same concerns.

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  • M 4 years ago

    Correct me if I’m wrong, but it looks like the real gem here is you don’t have to refinance to establish your new readvanceable limit on the HELOC? That means people are able to borrow in places like West Vancouver at full rate, even though prices are down 15% or whatever?

  • Trader Jim 4 years ago

    Classic central bank. The BOC executives are reporting things are fine based on traditional metrics, while the staff with actual talent is releasing staff notes explaining underlying issues not being monitored.

    This actually happened with the financial crisis in the US. Ph.D’s in the basement of central banks were warning, but top brass was saying the surface metrics they use are pointing to mild issues at worst.

    • Maxtor 4 years ago

      I’m pretty sure both the PhDs and the higher ups didn’t have a clue what was going on.
      Neither then nor now.
      Economists as a profession are competing neck to neck with sorcerers from the middle ages for credibility.

  • Oldguy 4 years ago

    If I understand this correctly, this is just a fancy name for a perpetual interest-only mortgage. If that is the case, then higher prices and money launderers are the only way to ever get ahead of the debt curve. If prices go down, then that’s gonna be a big problem.
    So what are the politicians to do? The same thing they have done for 30 years: welcome the laundered money and hope they don’t get caught.
    Plus ca change…

    • Nobody 4 years ago

      Great point, our corrupt and greedy government will continue to ignore the money laundering that is pricing out many Canadians in favour of protecting the money launderers, speculators and investors that plague our real estate market. This is late stage capitalism at its best, the rich/poor divide will grow at a even faster pace now.

      • BankerWanker 4 years ago

        Its just the greedy central banks and their idiotic policies. If they didnt debase money so much and interest rates were 5% real estate wouldnt be used so much as a store of value.

        Their end game is turning us/can into a 99/1% society like mexico or asia. Ultra rich and everyone else poor relying on govt handouts.

    • Bluetheimpala 4 years ago

      Like I told my father recently, if I’d read this 5 days ago I would’ve agreed but BC has created a commission to investigate. Will it most likely be a wet fart that doesn’t accomplish much but costs tax payers a bundle, you bet…but the mere fact of its existence is going to most likely scare the bulk of the money away. Drug dealers and other organized crime are stuck because that’s what they do but any capital flow that isn’t above board will taper significantly. You’d be a fool to NOT be looking for a 6-12 month exist strategy because IF the commission does actually gain a foothold (oh and don’t think ON will follow suit…) they will LITERALLY just start taking assets and the onus will be on the owner to provide the funds were not illicit AND taxes were paid. They were already rolling the dice so to speak by doing illegal activity…the idea that all the western money will just come to ontario is not realistic in my opinion. Tock.BD4L.

  • MH 4 years ago

    So it’s like a rolling refi into a higher rate? That’s some weapon-grade bankster racoonery.

    Why wouldn’t they? They know that taxpayers will be footing the bill anyway…

    • Bluetheimpala 4 years ago

      Makes me want to puke. If you recall, in 2007 the last stages of the RE correction was the financial alchemy that kept everything going for another 6 months. Maybe this continues for a little longer but I’ll put it this way…I know someone, couple with two young children, with their HHI is close to $180-200K and if he hits full bonus they are bringing in a cool $230K approx before taxes. He has a million dollar mortgage in etobicoke. Last time I spoke with him, 2 months ago, he said he was fucked if he can’t hit his bonus and he has debt out the ass….$180K HHI with an upside of over $200K. Fully employed. He is definitely the type of person who would continue to ratchet up the debt if he could survive another 6-12 months because we’re trained in the west that tomorrow is better than today and no one every loses. That is scary. Tock. BD4L.

      • SUMSKILLZ 4 years ago

        Some long running family businesses are also choking on debt, having tried via investment, to compete with lighter overhead, faster moving, newer players in their market. They never had competition from outside their geography before too. The debt is tied to their homes, if the company fails, they loose it and their home and possibly their parent’s home, the family cottage, etc.. Numerous family members also work for these firms. If the firm fails, a lot of dominoes fall swiftly. Folks were counting on the bounty of the firm helping them settle up their personal debts, some time into the future. They never even imagined not being in a position to service them, month to month. The thought had never entered their mind when they took on the debt.

  • Rana 4 years ago

    Feeling sad for hard working people who bought at the peak

    • JC 4 years ago

      At least they have a house to live in. They can live out the correction in their homes if they need to. I feel sorry myself for saving 100k in 3 years to buy a home for my family to live in but is now priced out of the market in KW. A decent SFU goes for 500k. All I want is for prices to drop down to 2016 levels again. Read somehwere that prices jump 40% in KW at the hight of the market in 2017. Makes me sick. Don’t know if I should FOMO in as people from TO keep migrating here pushing the prices higher. Or to stay put and save another 40k in cash and hope prices don’t keep jumping up next year. Any advice is welcome.

  • @xelan_gta 4 years ago

    HELOCs and Private Lending are definitely big sources of risk at the moment.
    Very important article:
    BoC is totally OK with RE prices normalization and negative equity homeowners.
    Poloz will not save RE market from further price declines.
    Don’t say you haven’t been warned.

  • B.C. 4 years ago

    The popular UTuber, Mike Martins, from cowboy town Merritt, B.C. , did a short video (9 minutes), … when people sign up for a big debt …they must ask themselves the question…can they realistically expect to conquer this debt?

  • @xelan_gta 4 years ago

    I assume you are bullish on RE so I will reply accordingly.
    You are right, reliability of BoC forecasts is low, but bears raising concerns about RE since 2017 and since 2018 openly pointing to recession on the horizon. GDP downward revisions are not surprise to bears in fact that’s what they are warning about. I’m pretty sure Poloz is working on another downward GDP revision as we speak.

    I agree with you that Poloz is guided by inflation forecast and closely watching GDP and unemployment. He will definitely ease if inflation expectations decrease.
    But if you imply that housing downturn will be strong enough to drag down inflation, GDP and raise unemployment on a national level I would not be so optimistic about that because at this point housing downturn may be already strong enough to reach the point of no return.

    Rate cut is a clear signal of recession avoidance and success rate of central bankers of avoiding recessions is very low. In addition to that, I would advise you to find an answer to the question of why multiple rate cuts done by Fed in US 2007+ failed to stop the housing downturn. As soon as you find an answer to this question you’ll have a pretty good idea if rate cuts in the future will be able to stop RE correction in Canada or not (especially with very low room for rate cuts we currently have).

    Regardless Poloz is doing everything right because debt-to-income of Canadians started growing again which means credit tightening is not very efficient at this point in reducing household indebtedness. We won’t be able to reduce debt levels without RE prices reduction or widespread defaults. That’s why BoC is OK to engineer a solt landing and allow RE prices to decline.

    The last thing I want to mention is GTA market. The latest data is strong and Vancouver was also booming 3 years ago, nobody would think at that time that market would be in free fall as it’s happing right now over there. You think GTA is different and has strong fundamentals. Let’s have this discussion when short term rental of non-primary residences on Airbnb will be prohibited in GTA(end of summer 2019), money laundering is addressed in Ontario, true ownership and assignment flip databases created.
    When we at least approach the level of regulation BC then let’s review fundamentals. I can guarantee you that GTA market will be crashing similarly to Vancouver if that happens.
    Add to the mix potential regulation for HELOCs and Private Lenders and everyone will understand that if median income family can’t afford median priced house in the same city – then prices are clearly overvalued and not supported by any fundamentals. Plain and simple.

    • MM 4 years ago

      Bro, be more accurate in clicking “reply”, wrong place:)
      Bears have been raising concerns not since 2017, but since 2008, lol.
      You are one of them…I saw your twitter couple of years ago…Sorry to see that your forecast is still failing. Hard to be a real practical RE bear, unlike just a forum troll.

      That is actually exactly the reason why your “guarantees” are not OK. History, bro…U need success history for predictions:)
      Your forecast was literally that rate hikes will burn real estate market. Rate hake stage is over and Poloz was shortsighted, but not stupid enough to make a crisis-scale overkill with rates. Now you talk about risks during rate cuts phase…No problem, do that. But its your next forecasts, while we clearly noted what happened with the first one:)

      And please don’t use arguments like that…I have hard time believing that even you believe in them…Ontario is not BC…NDP and PC are two completely opposite parties with different views.
      BC today is literally an experiment of all naive socialists with codename “Can I harass investors and don’t have consequences?”. The lack of economic education creates a demand for such experiment, so it is happening. Foreign tax, rent cap tightening, empty tax, countless other hostile things…NDP should just make their way into it and demonstate to entire country how it becomes a Venezuela-style banana republic after harassing businesses.
      For money laundering same story, it was originally asked by NDP to use that kind of regulations to make another hit on real estate…I don’t know what happened, but BC hasn’t done it…instead we saw 5 different sources reporting money laundering in a single month…what a coincidence…Obviously NDP can spare some taxpayer’s money to purchase such reports.
      If I were NDP, I wouldn’t even bother making them…I would just introduce another insane law against rich people and nobody would oppose.

      Ontario on the other hand implements completely different strategy, still suffering from legacy of feds and Wynne. Saying that Ontario would follow BC in any regulation is not just unlikely, its crazy.

      You can definitely make stories that central banks often screw up etc…but nope, bro. Just look charts. Not true that rate cut periods are crisises in 50%+ cases. Quite opposite.

      Meanwhile, if someone is struggling and having underwater risk, just today HSBC announces first superlow 10y fixed rate 3.24%. The lowest 10y rate in Canadian history ever.

      • Evidence 4 years ago

        Lol! Delusional!

      • Joe 4 years ago

        @MM, I agree, Ontario is not BC and Toronto is not Vancouver! Fundamentals in Toronto are much stronger than Vancouver. Good point catching that bears have been predicting the crash since 2008. I wasn’t in the market at that time so I can’t confirm this by bears definitely have been talking about the crash since 2013/2014. If you bought a house in Vancouver (even in the hardest hit area of the decline now) in 2013/2014, you will still be net positive. But most bears would only say they predicted the decline in 2017!

      • Cto 4 years ago

        You know mm…. if you look at a chart you’ll notice that the bank of Canada has been lowering interest rates for 30 years all the way from that high 20% you were talking about. To 0.5%.
        BOC lowered them right down to a point where they’re almost zero and for the first time after 10 years raise them five quarters 1.25%. !!!Peanuts…. there still peanuts!. And yes he put a real stopper in the housing market. Doesn’t that strike you just a little bit extraordinary? Rates are the lowest they’ve ever been in history and still are, but the housing market can’t take a 1.25% raise.
        Holy over-leveraged.!!!

        • MM 4 years ago

          Cto, are you another guy saying “If economy is not ready for 20% rates, its a problem”?
          Sorry, 20% are not happening. BOC has no biases towards that magical number, only you have.
          To be willing to have 20% rates, you need justification WHY its beneficial to have that rate. BOC doesn’t have sucg justification.
          For BOC inflation is a primary target and whatever rate is needed to keep it in the limits. And by the way, 5 rate hikes in less than 2 years, for me it sounds not like lowest rates in history. It sounds more like an overkill spree.

  • Iain Palmer 4 years ago

    There are several points to consider here. First is that a HELOC-Mortgage is a brilliant product. It allows you to use your home as a bank. Why pay prime plus 3% when you can have prime plus 1%. Second is that the product allows multiple mortgages and or multiple HELOCS. This allows the home owner to take out funds and invest those funds else where (mutuals, RRSP’s etc) and keep the interest only payments separated, which are by the way tax deductible. Third it allows the owner to draw down cash by writing a cheque, in the case of an emergency the time element can become critical. Fourth existing high rate household debt is not being reported here and it is the the one most indicative of financial difficulty. In any analysis of debt there is good and bad types of debt – high rate unsecured loans and credit card debt and long term lower rate fully secured mortgages (including HELOCS). Who is to say that this is not just movement of debt into a better rate. Fifth, in a long term analysis of home Price growth (in Vancouver), say over a thirty year period, the average annual compounded rate of growth is around 8%. Of course it has had its ups and downs but an average over 30years is a good indicator of growth. The mortgage interest rates don’t come near this so what is the big fuss. As a final note I don’t believe the money laundering issue is affecting home prices any where near what people believe. Government inefficiency is something that allows the laundering and also makes us all pay higher taxes because of their failure to monitor non Canadians properly. Don’t let us forget local government and how long and difficult it is to get building permits. Canada is the best country in the world to live in and everyone with money wants to live here, it’s time we taxed them on their worldwide income.

  • Oldguy 4 years ago

    I realize that I am not the sharpest tool in the shed, but this is one of the most confusing discussions that I have ever seen. You seem to be talking out of both sides of your mouth, and perhaps a few other orifices. Maybe you could explain exactly what point you are trying to make.
    While you are at it, you might explain a couple of the statements that you make.
    First, exactly what interest do you claim to be tax deductible? I have no doubt that many of us would find this information useful.
    Second, could you expand on your argument about the relationship between the compound rate of growth in real estate prices and interest rates. You might get a Nobel prize for this one.
    By the way if you are correct that the compound growth rate of prices has been 8% over 30 years then prices should be about 10x what they were 30 years ago. If you compare this to the generally accepted historical rate of 5%, which works out to a quadrupling(4x) over 30 years, then it is easy to see why some folks believe that Vancouver prices are wildly out of line.

    • Iain Palmer 4 years ago

      Firstly if you take money out of a HELOC or any mortgage for that matter and invest those funds then you can write of the interest on the borrowed money against the return on the investment. Second there is information out there (REBGV) that will confirm an 8% growth in RE prices for over 30 years. You are absolutely correct in that house prices have increased 10 fold over that time. There is even evidence to support the 8% growth rate since 1947 found in the archives at the Vancouver public library.

  • Iain Palmer 4 years ago

    I would even suggest that if you researched enough that you might find the 8% rate of growth has been with us in Vancouver since 1917, which is over 100 years…

  • Oldguy 4 years ago

    I would like to be a fly on the wall when you have your meeting with the CRA folks to explain how you are deducting mortgage interest expense on your tax return. This ain’t the US of A.
    The long term price appreciation rate is 5% unless you cherry pick a period that suits your purpose.
    For sake ok argument, let us say that the cost of a home on the West Side today is 3 million and prices increase at 8% for 30 years. So at about the time that my grandchildren are looking to buy, the average price will be 30 million. You see the problem? Can’t happen unless every property is owned by a zillionaire, a foreign buyer or a money launderer. You can work the same numbers backwards and see how we got to where we are today. Same answer: zillionaires, foreign investors and money launderers.
    So we know where we came from and we can see where we are headed. Does anybody care?

    • Joseph 4 years ago

      Good post. And I second your mortgage interest rate point. I don’t know much, but I know what you said is true. Anyone who thinks otherwise, I’ll need to see proof.

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