The irresistible

Will the federal budget blow up HELOCs? What a surprise that would be to three million little debt-snorfling voters.

Big fanfare this week for a new report by a federal agency that frets over people’s finances. Needless to say, they have a lot to worry about. Most of us are basket cases when it comes to money. Almost half couldn’t survive missing just a paycheque or two. Nine in ten haven’t maxed their TFSAs. Family debt tops $2 trillion – bigger than the entire economy. Mortgage loans shot higher last year even though house prices went down. Quelle mess.

Home equity lines of credit have been the hottest banking product of the last decade. No wonder. People have stored most of their net worth in a single asset – their houses. So far we’ve borrowed more than $300 billion against residential real estate, half of it spent on the same properties, to finance renos. This doubling down is insane, of course, when home values have peaked and interest rates are rising. But, there ya go. More for Ottawa to worry about.

The new report confirmed what this blog reported last year – a quarter of all the HELOCers are paying nothing on their loans. Only interest. And most of them are using the lines themselves to get the interest money itself – so the debt keeps expanding until it hits the limit. The feds also found half of Canadians have no clear idea how these lines work or the risks involved.

And, yes, the dangers are real.

HELOCs are demand loans. The bank can call you any day of the week and demand the thing be repaid. If real estate crashes or your financial situation hits the skids, that phone call is not so unlikely. And home lines of credit are almost always variable – so every time the Bank of Canada raises its benchmark rate, your borrowing cost goes up. (There are two more increases expected in 2019.) Lenders can also decrease your line’s limit arbitrarily – which sucks since a third of all borrowers say they often or always use HELOC money to make other debt payments.

So every year more people with houses borrow against them, and the HELOC balloon grows. Currently about $100 billion is not being paid off – at all. Meanwhile the cost of carrying all this debt has increased substantially over the last year, in which the central bank jacked rates three times. Home equity lines have turned into quasi-mortgages, a form of debt which will typically last decades or maybe forever – draining off cash flow and eroding real estate equity.

So why do people do this?

Simple. HELOCs are like me – seductive and irresistible, but dangerous when abused. They’re also cheap – prime plus a half for most borrowers. Banks dole them out like lollipops – up to 65% of the equity in a home can be borrowed. They’re open – no term – and can be borrowed against or paid off at any time without penalty. And if you use the money to invest, the interest may be deducted from taxable income. But, sadly, since three-quarters of folks take the money for renos or debt payments, they entirely miss this benefit. Once again, financial illiteracy on full display. No wonder most people live on the edge. By the way, Ottawa’s survey also revealed those aged 25-34 would seriously struggle if their monthly payment increased by just a hundred bucks.

Bankers have been routinely offering people equity-based lines when they take out mortgages. Yep, debt and more debt. Plus there are financial products increasing the limit on a HELOC as the principal on a mortgage is reduced. So overall indebtedness never really falls – you just swap a fixed-rate, stable borrowing for a demand, variable-rate one. No wonder Bay Street loves this stuff.

Was this report, coming just weeks before the next federal (pre-election) budget, timed to set the stage for changes?

I hear it’s under consideration. The 65% equity-borrowing limit could become 50%, then reduced further in subsequent years. Plus, interest-only payments could be banned, with a requirement for banks to adopt blended payments, as with mortgages. Such changes would be prudent and in the public interest. But they’d obviously shock more than a million people who pay nothing against their loans and steadily increase their level of poochedness.

Your neighbours, in turning their homes into banking machines, have created a $300-billion bomb. Ottawa, for its part, has turned a blind eye. Do you think politicians will now do the right thing?

Me neither.

As predicted

On the final day of 2017, this foolhardy blog made some predictions. In the noblest tradition of accountability, we’ll ignore the ones that were turkeys (‘a balanced portfolio will do just fine’) and pretend that everything printed here, lo, came to pass.

Anyway below are the top four things forecast for the year just passed. Apparently I am (almost) Nostradamus.

  • The cost of money goes up in 2018. A lot. The Bank of Canada will increase its benchmark rate three times.

It did. Our central bank raised its benchmark rate in January, July and October.

  • The Fed goes three times, too. At least. That will bring to eight the number of quarter-point jumps in roughly 24 months, taking the rate from zero to 2% or more – with further increases expected in 2019 and 2020.

Ditto. The American central bank jacked rates four times during 2018. It has now indicated a ‘neutral’ rate is getting closer, which will mean 3-4 more over the next 18 months.

  • Five-year, fixed-rate mortgages will hit 4% in 2018. The benchmark central bank mortgage rate will be more than 5.5%. Newbie real estate buyers will have to qualify at the higher of that, or the contract bank rate plus 2%. Ouch.

Close, but no cigar. The best discounted five-year rate at the big banks is currently 3.74%, and the benchmark mortgage stress test rate is 5.34%, with the effective rate at 5.74%.

  • The stress test, B20, will crater sales and depress prices for at least first three months of 2018. There’s no point predicting anything past that. This is too fluid a situation as rising rates and tighter regs do battle with the house-horny loins of the Mills, who now compose the largest demographic. God help us.

Well, that happened, too. But it took longer for the effect of B20 to show up in the stats, and when it did the impact was fierce. New evidence was reluctantly, painfully released by realtors on Tuesday. It shows the market has started into a correction that is widespread – and unlikely to end soon. The coming spring market could end in tears.

Here’s a summary of the carnage: It was the worst year for sales in more than half a decade, rolling the total back to 2012 levels. The number of transactions was almost 20% lower than one year ago. “Monthly declines in activity since September,” says CREA, “have fully retrenched its summer rally and returned it near the lowest level since early 2013.” Yikes.

Led by Vancouver (where else?) things slid in 60% of all Canadian markets last month. In Toronto the plop was 15% below long-term averages, while in YVR the decline was a withering 40%. Over the course of a year, buyers have retreated in three-quarters of the country, led by the LM, the Okanagan, Calgary & Edmonton, the GTA and Hamilton.

And, yes, prices are not immune, even though residential real estate is the stickiest of all assets. The value of a house, on average everywhere, is down 5% in the past year. That number does not capture the magnitude of the decline, of course, since markets improved last year before falling off the edge. As detailed here, the average detached house in 416, for example, is down 27%, or $432,000, since the spring of ’17, and off 19% in the past seven months.

This is the big unwind that a certain pathetic blog has forecast since many readers were in Huggies playing with their toes. Real estate markets do not crash. They deflate. It took six years in the US for things to unwind from their 2006 high – and they’re still recovering. When buyers vanish and prices slump, most sellers (being greedy) simply end their listings and wait. In the majority of markets that’s precisely what has happened. So a price decline when the number of available listings falls is telling. It looks like those owners who left the market to await better times will be selling for less next year.

What now?

The stress test isn’t going anywhere, it seems. Just days ago T2 said federal policies to cool off housing were doing exactly what was intended. No changes are foreseen. So new buyers or renewers changing lenders will have to prove they can buy at the benchmark level. Meanwhile the Bank of Canada is not done with rate hikes. Scotiabank on Friday forecast at least two more to come this year, taking five-year mortgages beyond 4%.

Household debt levels are going up, not down. Wage growth over the last year was less than the inflation rate. Mortgages are no less costly. The stress test remains in full force. Chinese buyers were warned by their government this week they could face ‘arbitrary arrest’ if they venture to Canada. So, kids, tell me where the buyers will come from to turn this ship around?

Oh, and here’s a new report from Capital Economics saying a glut of new homes is about to hit the market, especially in Vancouver – since developers failed to see the slowing market two years ago. “As has been typical of historic real estate cycles around the world, new supply will reach the market just as demand is falling.” In Vancouver that will mean 40,000 unsold units.

Hmm. You might have noticed there were no 2019 predictions published here in the final days of last month. Instead you got wimpy ‘expectations.’ I may have to change that going forward being, like, so awesome.

About the picture...

“I saw this photo in Melbourne Australia today,” writes blog dog Ellen, “and thought of your blog. I guess the message is: ‘why bother saving, you’ll never get there.’ No dog in sight though. My apologies.”