We’re seeing an increase in the number of people struggling with debt take advantage of higher house prices to refinance their credit cards. They’re doing this using their home equity either through a second mortgage or a Home Equity Line of Credit (HELOC). It’s become so common that the percentage of homeowners needing to file insolvency to deal with debt decreased to an all-time low in August 2017.
This information is available in the Hoyes Michalos Homeowner’s Bankruptcy Index (HBI). The HBI measures (monthly) the percentage of insolvent debtors who own a home at the time they file a bankruptcy or consumer proposal. Our goal with this index is to track the impact of the mortgage and housing market on insolvencies in Canada.
This index has turned upward since August. The reason? A reduction in housing prices in most major markets, rising interest rates and a tightening of mortgage lending rules.
Through our research, we’ve found four fundamental factors that increase the risk of insolvency for homeowners: rising interest rates, falling home values, credit tightening, and rising unemployment.
We’ve also learned that homeowners aren’t necessarily delinquent on their mortgage payments but on the unsecured debt they carry. In fact, the average insolvent homeowner carries an extra $72,510 in unsecured debt on top of mortgage payments.
- Rising interest rates
Interest rates have risen and the Bank of Canada suggests future increases are still likely. You can expect to make higher monthly payments when interest rates rise. Think of it this way – If you are paying 3% on your HELOC and your interest rate increases to 4%, that is a 33% rise in your interest payments. It’s time to reduce your principal to avoid that increase in demand on your cash flow. Take a careful look at your expenses. Can you afford to make higher payments? If not, change your spending habits to be able to accommodate the upcoming higher cost of debt. The sooner you plan for this the better.
- Declining home values
When it comes to declining home value, a HELOC creates added pressure of making sure you can sell your house for enough to pay off all the debts against it. It’s one more reason to plan to pay down your HELOC as soon as you can so that if you decide to sell, you don’t end up still owing money.
- Job loss, illness, etc.
Being prepared for a job loss is rare. The same goes for any sudden illnesses or workplace injuries. Situations like these are hard to predict; in their event, you want to have as little expenses as possible at such a strained financial time. If you don’t have an emergency fund and have used most of your HELOC, you have little financial room to maneuver in the event of a job loss or illness other than to take on more expensive debt. In my practice, a job loss on top of existing debt is one of the leading causes of bankruptcy.
How to Pay Down a HELOC
As with paying down any debt, the more money you can put towards the principal, the better. Take a careful look at all your expenses and track where all your money goes by determining your wants versus your needs.
If you’re having trouble setting money aside, pay attention to any big cash drains in your discretionary spending. Another important point is to avoid running up old balances again. You may not realize that you’re spending more than you make.
Now, we realize that budgeting may not always be the easiest thing to do. It’s the usual advice and it’s good advice for sure, but it’s not for everyone. If you struggle with sticking to a budget, start by getting an understanding of your spending habits. If you don’t already do this, start prioritizing debt repayment and ask yourself: Can I reduce any areas of spending?
It’s much more important and beneficial in the long-run to have a strong understanding of how you’re using your money.
Unfortunately, the days of record-low interest rates may be over, and you want to be able to stay afloat with all your payments when they rise again to normal levels. For that reason, I strongly recommend that now is the time to begin to pay down your home equity line of credit.
Doug Hoyes has extensive experience resolving financial issues for Canadian citizens. A Licensed Insolvency Trustee and co-founder of Hoyes, Michalos & Associates, he is also a Chartered Professional Accountant (CPA), Chartered Insolvency and Restructuring Professional and Business Valuator. He regularly comments on a variety of TV, radio and other media outlets on topics surrounding bankruptcy and consumer debt. He is the author of Straight Talk on Your Money: The Biggest Financial Myths and Mistakes…and How to Avoid Them.