Canada’s HELOC Problem Is One of The Biggest Risks For Real Estate

Canadian real estate owners received a windfall of equity over the past decade. Rather than selling for a profit, many are turning to home equity lines of credit (HELOC) to reap the rewards. The popular form of debt allows owners to borrow equity in their home, and pay it back like a second mortgage. They’re easy peasy, and may have been a major contributor to the collapse of the US real estate market in 2007. Let’s see how out of control Canadians have become, by looking at the size and scale of this problem.

The HELOC Problem

There’s nothing wrong with a home line of credit (HELOC), but there’s a lot that could go wrong. The Financial Consumer Agency of Canada (FCAC), a government agency in charge of consumer protection, noted having a HELOC “significantly increases” the chances of a mortgage holder defaulting. Besides increasing the loan-to-value (LTV) on real estate, it also uses equity that could be tapped during financial hardship. Over 40% of mortgage defaults that occurred in the US between 2006 and 2008 were homes with a HELOC.

HELOCs in Canada are also a little more complicated, since they’re often used to get more leverage. In the US, there were anecdotes about HELOCs used to finance lifestyle inflation. What’s the point of having a big fancy house you can’t afford, if there isn’t a nice car in the driveway – right?

In Canada, HELOCs are often used to finance down payments on additional homes. There’s no shortage of advisors suggesting a HELOC to buy a second home. Parents also tend to borrow HELOCs, and “gift” the loan to children for use as a downpayment. Now 35% of first-time buyers in Toronto, and 40% in Vancouver, receive down payment help from their parents – quite a bit is likely HELOC cash. That means Canadians are using leverage, to get more leverage – and lenders may not be fully aware.

Canadian HELOC Growth Peaked In 2017

Canadian HELOC growth is slowing, but after seeing explosive growth last year. The balance of HELOCs reached $286.81 billion in Q2 2018, up 1.83% from the previous year. That’s down from last year, when growth peaked at a whopping 12% in Q2 2017. For context, peak real estate price growth occurred in the same quarter last year.

Canadian HELOC Growth Vs. GDP

The growth rate of outstanding balances on home equity lines of credit (HELOC) and gross domestic product (GDP) in Canada.

Source: Better Dwelling.

Canada’s HELOC Debt Is Over 13% The Size of GDP

For some perspective, let’s contrast HELOC debt to gross domestic product (GDP). HELOC debt relative to GDP reached 12.89% at the end of Q2 2018, which is a slight improvement from the recent peak. The recent peak in Q2 2017 (a busy time for home equity withdraws) saw HELOC debt relative to GDP reach 13.17%. We know, those percentages mean nothing without context.

Even during the peak real estate bubble in the United States, HELOC use was lower. The HELOC to GDP ratio in the US reached a massive peak of… 4.5% in 2007. Post-correction, the ratio has fallen to just over 3% at the end of Q2 2018. When contrasted, Canadians are using an amazing amount of home equity, for such a small population.

Canadian HELOC Debt To GDP Ratio

The size home equity lines of credit (HELOC) debt relative to gross domestic product (GDP) in Canada.

Source: Better Dwelling.

The Canadian debt problem is so large, the numbers have stopped meaning anything to many. Canada’s HELOC problem is significantly larger than the US, when looked at on a per capita basis. Quite the accomplishment, since history remembers the 2007 US binge as a time of greed, excess, and ignorance. Meh, probably nothing.

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  • Angry consumer 6 years ago

    The primary reason is that most people can get a better rate from a heloc than what the banks are offering on a renewed mortgage….

    • Grizzly Gus 6 years ago

      I know you can get a lower payment by paying interest only. But where do you get a better rate for a HELOC instead of a mortgage?

      • Bluetheimpala 6 years ago

        I think we have a live one Grizz…this is the sort of thinking that caused this mess. tick tock. Happy long weekend everyone. BD4L.

  • SUMSKILLZ 6 years ago

    I guess the one positive is I’ll be able to hire a tradesmen to do small jobs. The days of, “I don’t get out of bed for less than $5000” phone calls, will come to an end. It has been madness in the GTA the last ten years.

  • Rick Abrams 6 years ago

    I love Better Dwellings but please, please learn about the cause of the Crash of 2008. You state: :They’re easy peasy, and may have been a major contributor to the collapse of the US real estate market in 2007. ”

    Individuals’ over leveraging homes played the same role in the Crash of 2008 as the manufacturers of ski masks play in bank robberies.

    The sole cause of the US Crash of 2008 was corruption where Wall Street intentionally purchased bad mortgages, then bundled them as great mortgages with the help of lying rating agencies and then sold the bundled mortgages as top notch investments. Then the final piece of corruption was the same WS execs who created the bad bundles, bought “insurance” on the bundles so that they could collect millions of dollars if the bundled mortgages under performed. This was like drugging your own race horse and then betting against it.

    Only, this “insurance” was not insurance which is why Wall Street called them Credit Default Swaps [CDSs] to avoid insurance regulation. The only person who can insure something is the person who has an ownership interest (and a lender qualifies for real estate as they suffer the loss). Once the bundled mortgages were sold only the buyer, like Iceland, had an ownership interest and only Iceland should have been permitted to purchase a CDS on its mortgage bundle. Instead a corrupt US administration allowed the Wall Street executives to personally buy CDSs on many bundled mortgages so that when they under performed, the executives could cash in.

    Extending the horse racing analogy, it was as if a group of owners all drugged their horses and they all bet against their own horses and all their friends horses. The race track would go BK. While one can see the criminal fraud in drugging horses and then betting against them, the US government found nothing wrong with doing the same thing with mortgages.

    The role which that a few individuals over-leveraged their houses to purchase more houses played in the crash was brokers convincing unsophisticated buyers to engage bin this practice. Often the brokers were the ones who filled out the paper work for the liar loans without the “purchasers” knowing. THe brokers made money by selling the defective mortgages to WS which wanted bad mortgages more than they wanted good mortgages. The reason? Bad mortgages turn sour and crash a bundle of mortgages faster than good mortgages which may never turn sour. The WS executives needed the bundles to crash in order to collect on their CDSs and the sooner the bundles crashed the quicker they would get paid. Of course, this scam would BK their investment houses, but they did not care. This was Accounting Control Fraud where the purpose is to loot the business or government and if it crashes, who cares? Google William K Black

    The unsophisticated buyers who over-leveraged their properties were on the road to financial Hell. They were only pawns. Near the end of the scam, the local mortgage companies did note ven bother to find human beings. They just wrote up fictitious mortgages and sold them to WS. The broker paid the mortgages for a couple months until it was bundled and sold and then he stopped paying which would cause the bundled mortgages to crash sooner.

    Please do not say that this is a bad business model. It was not a business model designed to keep the investment houses solvent; it was Accounting Control Fraud which is designed to BK the business or government. Los Angeles is awash in Accounting Control Fraud.

    • SUMSKILLZ 6 years ago

      I worry about all the corporations that own bundles of condo units in Toronto. I have no idea of the scale of the phenomenon. I rented one from a corporation and they (three wealthy guys) owned and managed maybe 20 apartments in various condo buildings, units they bought cheap in 2008. I have no idea how strong their balance sheet was. They were a good landlord. Attentive and fair.

      I guess I wonder if the math begins to look bad, these kinds of corporations will decide to unload bundles of units to liquidate. How many firms own bundles of condos in Toronto? to use the bundles of mortgages analogy. Not the same thing at all, but still a curiosity of mine. I spent a few years chasing a cheap condo from blueprints, only to find out the choice small corner units were all sold before the first day the sales centre opened. I heard, someone bought “blocks of units” over and over again.

    • Bluetheimpala 6 years ago

      Similar to 2008, the over leveraging which is bubbling to the top is indicative of something much worse; systemic fraud. To your point Rick, in 2008 regulators chose to turn a blind eye on CDS and other leverage-over-leverage-over-leverage product that no one could track the origination of the underlying debt other than ‘trusting’ the financial professionals. We know mortgage brokers were fudging numbers. Banks were doing anything to get foreign money into their accounts. Mortgage lenders and credit unions stepped in to lend money to anyone who could lift a pen. Community lending is still unknown but the recent ‘brampton margin call’ indicates it could get hairy. No transparancy in number corps and reporting of transactions meant grey money doing whatever it wanted. Where could this go? Not sure, but we’ve seen there are properties withe 2-5 times debt to ‘equity’ which, ultimately, we don’t know what the ‘equity’ is worth…leverage-over-leverage. if the underlying equity is inflated and the secondary and tertiary loans are based on this (compounded of course!) then we end up with a shitty McMansion with $3M of debt against original equity of $1M that was inflated (Infinity and beyond!) in the second round to add more leverage. Which in realty is closer to $700K, if that. So the underlying asset is worth $700K, debt of $3M. Debt is VR so the carrying has been ratcheting up. Why do you think banks are padding their balance sheets? Looking to bring in more chequing accounts and more of a cash base? As the lies and fraud unravel all we’re left with are pigs and possums. Tick tock. BD4L.

    • MeowMix 6 years ago

      You’re an idiot. You don’t even understand the mortgage bundling issue. The grading was non-standard because they prime borrowers at subprime lenders. Please read a book before simplifying one of the biggest economic downturns in history.

      There was no “single cause.” There were amplifying factors such as leverage that are triggered by exogenous factors. Not wearing a seatbelt doesn’t cause car crashes. It does amplify the damage of an impact however.

    • gary 6 years ago

      Yes I really like your explanation Rick Abrams. It puts a lot of things into perspective.

  • Rick Abrams 6 years ago

    Carrying too much debt can be a problem.

    (1) If prices fall, the property can be underwater

    This is not a real problem unless the owner’s income also drops and he cannot finance his debt. It is a problem if he has to sell in which case the sale price may not cover the mortgages. My advice for Angelenos is “Do NOT take out a second mortgages as the hyped market is build on fraud.”

    (2) Excessive mortgages consumes too much income

    When an owner takes out a larger loan against the rising value of his house, he is paying more for the same home. Paying more and not getting more is not wise. Owners need to fighting against the idea that they are buying a much of stuff and hence are getting more. In most cases, owners are living beyond their incomes. They do not need a boat, nor do they need to eat out so much or at such fancy places, nor do they need such expensive clothes, or vacations. Consuming future income to pay for current pleasures is not wise.

    On the other hand, like people who have to turn to living off their credit cards, when it is a choice between not eating and over-leveraging, the latter is the wiser option.

    • Beh G. 6 years ago

      No, the biggest problem is that unlike mortgage debt, HELOCs

      1 – Can be called in by the bank at any point and have to be paid back.
      2 – Suggest underlying equity of at least 30% (last time I checked).

      That means that if banks fear losses due to further depreciation in prices, before we even see a major increase in mortgage defaults, we are likely to hear about banks demanding repayment on HELOC’s because they will end a bad investment without losses, unlike a mortgage default which in majority of cases don’t even have enough equity to cover foreclosure costs.

  • Cash 6 years ago

    anyone looking to understand what all this debt means in layperson’s terms or trying to explain Canada’s current predicament, please take 30 mins and watch this clip on youtube.

    very good watch and remember that Canada’s household D/GDP is > than the US circa 2007.. Best to be smart with your liquidity at the moment.

  • scott 6 years ago

    The CMHC enables all of this bullshit to continue. Above people were taking about CDS but they didn’t mention CDO’s or the other mortgage securities that caused the whole system to break. In the US the mortgage security market was private in Canada they are all banned by a crown corporation back stopped by Parliament that creates the moral hazard that allows lenders to sell a mortgage and reap profits immediately. As an investor having the Canadian government guarantee my mortgage bond purchase allows me to buy with no questions asked. The CMHC needs to go.

  • Marbella 6 years ago

    Nice post.Thank you very much

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