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August 7, 2018 | Lines

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Do you have a line of credit?

Makes total sense. You should. Keeping enough cash in a savings account for six months of living expenses is so 1990s. So-called ‘emergency’ funds can be a big drag on family finances since this money is actually losing money after taxes and the rising cost of living. The banks pay you next to nothing, even in a HISA, and the odds are you’ll never have an emergency, anyway. Nope, this pile of dough should be invested safely inside your TFSA where it will be growing instead of being diddled by inflation and savaged by Bill.

This is what LOCs were made for. You set one up. It costs nothing to have in place. If the cat gets caught in the garburator resulting in a $5,000 vet bill, just write a cheque. The funds come out of the LOC. You move money around later to cover it, or take payments out of the feline’s allowance. Meanwhile your money is making money.

HELOCs, on the other hand, are a different beast. Unlike a personal LOC for $10,000 or $50,000 which you keep for unhappy cat-days and is unsecured (the bank makes the loan based on your creditworthiness), this one is linked to your house. So a home equity line is secured, and (like a mortgage) registered against your deed. This usually results in a lower interest rate, and a far greater amount of money. You can borrow up to 65% of the equity in a home, or 80% if you combine it with a mortgage.

HELOCs have been all the rage for a number of years – for obvious reasons. As real estate values blossomed, so did equity. This was an easy way to suck off that windfall gain and use it for something else. Like buying a boat (bad) or investing in a financial portfolio (not so bad). If the loan proceeds are used for a purpose which generates taxable income (owning ETFs or an apartment building, for example) the interest is deductible. Not so with the boat.

One of the biggest uses of HELOCs has been for renovation – using real estate equity to invest in the same real estate, which is kind of like a snake eating its tail. The property may be improved and might even be worth more, but it comes with a legacy of debt. If house values retreat again, the debt remains. It’s a gamble.

Having said that, home equity LOCs are growing faster than mortgages. Twice as fast, actually. CMHC’s latest report shows Canadians are eating through their home equity in the most voracious manner ever seen. As mentioned here before, a huge number of people are making no principle payments on their outstanding loans (about 40%) and one in four make no payments whatsoever, not even interest. Their LOC balance just grows each month until the ceiling is reached.

This is worrisome, and a potential bomb for the economy. But you hear nothing about it, since Canada seems more focused on women’s issues in Saudi Arabia and transgender rights in Toronto. Meanwhile the cost of carrying a HELOC has jumped a full 1% in the past year (that upped payments by more than 7% in the last quarter alone), and we’re on track for four more interest rate increases in the next 12 months.

There are 14 million households in Canada. Of those, about 9 million own real estate of some kind. And of those 2 million have lines of credit. So, almost one in four homeowners have HELOCs – some of them in conjunction with a mortgage, some without. With four in ten of those folks making no effort to reduce their debt (maybe they can’t?), and interest rates marching higher, this is a potential threat to the economy. Even worse than Nickelback.

Meanwhile CMHC has another interesting observation: fewer people are getting mortgages (house sales are down) but the amount borrowed is on the way up. That doesn’t sound good.

In fact, Canadians tell pollsters paying off debt is more important than investing – but they’re actually doing neither.

Draw your own conclusions.

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August 7th, 2018

Posted In: The Greater Fool

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