Dept traps
Canadians have been using their homes as piggy banks. Has the reckoning begun?
MacLean's
Joe Castaldo
13 November 2017
Photo illustration by Stephen Gregory and Heshmat Saberi
In 1998, Ann bought a one-bedroom condo in the Kitsilano area of
Vancouver. Gainfully employed at a printing company, she found the
monthly mortgage payments were within her budget (Ann and others quoted
in this story asked that Maclean’s not use their full names). The
building was on the older side, and eventually she got the itch to
update the decor. She intended to replace only her bathroom sink; she
ended up renovating the entire bathroom. “I remember thinking, ‘Well,
now that I’ve started…’ ” The kitchen came next, then the living room
and finally the bedroom. Ann thought the renos, funded partly on credit
and spaced out over a few months, would boost her condo’s value. She
also wanted to keep up with her neighbours. “Everyone was doing
something,” she says.
Finances became tight afterwards, and she only paid the minimum on her
credit card each month. Every year, her condo fees rose while her
salary at the printing company (where she still works) stagnated. She
began relying on credit for everyday expenses, and later took out a
second card.
Soon, one of her banks began calling with a solution to help manage her
debt. She ignored the inquiries, preferring not to think about her
finances, but she started to feel desperate: “I just wanted to do
something, and that was the only thing coming my way.” The bank offered
a loan at a low rate to pay off her high-interest credit card debt, and
she ended up taking out a second mortgage for $80,000. The interest
rate still wasn’t manageable. “It was a huge mistake,” she says.
Saddled with two mortgages, rising condo fees and a flat income, she
continued relying on credit cards. Surprise expenses, such as dental
work, added to her debt. Embarrassment kept her from seeking help.
Three years ago, she decided to sell her condo. Despite Vancouver’s
booming market, the sale didn’t solve Ann’s financial problems. She
moved in with a friend and was able to pay off her mortgages, but she
couldn’t make much of a dent in her credit card debt.
This year, Ann turned 64. She was carrying $70,000 in debt, and knew
she couldn’t work another decade to pay it down. That realization
prompted her to seek help, and she eventually met with an insolvency
trustee. Earlier this year, Ann’s trustee filed a consumer proposal on
her behalf. Less severe than personal bankruptcy, a proposal is an
offer to all of an individual’s creditors to pay a portion of debt
under a strict plan over a maximum of five years. The remainder is
discharged. Creditors typically agree to these arrangements since they
are guaranteed to recoup at least some of their money. For Ann, filing
a proposal came as a relief. “I actually feel like I can breathe
again,” she says.
Other Canadians are still suffocating. Earlier this year, the household
debt-to-income ratio hit another record of 167.8 per cent. A long
period of abnormally low interest rates has enabled Canadians to carry
massive debts, since monthly payments appear manageable. Further, in
cities with rising home values, particularly Toronto and Vancouver,
homeowners can secure a home equity line of credit (HELOC) to pay other
debts or simply fund their lifestyles. Last spring, the Financial
Consumer Agency of Canada warned that the increased use of HELOCs “may
lead Canadians to use their homes as ATMs, making it easier for them to
borrow more than they can afford.”
Insolvencies, though, are rare. As of the end of July, there were
nearly 123,000 consumer proposals and personal bankruptcies filed by
Canadians this year, a decline of 1.2 per cent from the same period
last year. That might be a sign of fiscal prudence, but it’s also the
result of record low interest rates that ease debt-carrying costs.
Scott Terrio, an insolvency estate administrator and president of Debt
Savvy in Toronto, calls this phenomenon “extend and pretend.” Canadians
can extend their debt repayment terms and pretend to live a lifestyle
they can’t otherwise obtain. He sees it all the time—couples with
decent jobs carrying large mortgages, and putting daycare, cars and
vacations on credit.
Some reach a trigger moment when they can no longer pretend—a job loss,
say, or divorce or illness. But lately Terrio has noticed a change in
his business. More clients are coming in because they’re simply tapped
out. As with Ann in Vancouver, there is no trigger. “It’s a gradual
realization for some people,” Terrio says. “They can’t do it anymore.”
Lana Gilbertson, an insolvency trustee in Vancouver, has seen the same
change. “Nowadays, they have jobs, they’re making money, they’re
plugging along, but they’re just in over their heads,” she says.
The cost of borrowing is set to rise, adding strain to households. The
Bank of Canada hiked rates twice this year, signalling more could be
coming—depending, in part, on whether households can handle it.
Economists at TD Bank Group believe two more rate hikes are likely next
year. That will cause rates on everything from lines of credit to car
loans to mortgages to tick up. At the same time, house prices are not
rising as quickly as they once were in many Canadian cities. RBC
Economics forecasts home prices in Canada will increase 11.1 per cent
this year—and just 2.2 per cent in 2018. Canadians won’t be able to
pull cash out of their homes so easily to get themselves out of
trouble. “The insolvency business is cyclical, and we’re at least a
year overdue for shedding blood in the system,” Terrio says. “If ever
we were poised to hit that right on the head, it’s now.”
For some Canadians who struggle with debt, the problem can be traced
back to real estate. In a survey TD released in September, 56 per cent
of respondents from across Canada were willing to exceed their budget
by up to $50,000 to purchase a home. At the same time, 97 per cent of
homeowners said they wished they’d factored in other obligations before
buying, such as property taxes, maintenance costs and “overall
lifestyle expenses.”
The problem is not confined to Toronto or Vancouver, where huge price
gains have enticed buyers to stretch themselves for fear of getting
permanently priced out. In Regina, Joshua and his wife purchased a
house in 2014 when expecting their first child. Both 24 years old at
the time, they carried about $35,000 in debt between them, mostly tied
to student loans. “We rushed into getting a house because we just
thought it would be the right thing to do,” Joshua says. “It almost
felt wrong to be renting and having a kid.” (Joshua’s mom pressured
them to buy, too.) In one weekend, they viewed 16 houses. The very last
one felt right. They put down five per cent and moved in.
But the couple was blindsided by maintenance costs. Their furnace
needed repairs, and they later had to replace the water heater, which
set them back hundreds of dollars. After expenses, the pair has
virtually no cash to put toward their debt. Joshua’s card is maxed out,
and his wife’s card is close to the limit. Joshua says they’re frugal
(splurging means going to Subway) and live paycheque to paycheque. The
situation became worse this year. His wife is on maternity leave with
their second child and their variable mortgage rate ticked up. “Just
the way the rate is fluctuating is killing us,” Joshua says, who works
in sales at a telecommunications firm. “It can’t keep changing like
this.”
Staring down tens of thousands of dollars in debt, rising mortgage
costs and no foreseeable way to substantially boost their incomes, the
couple decided to sell their house and rent. They’re not expecting a
windfall. A while back, their basement flooded and they used the
insurance money to repair the foundation. The basement had been
finished, but there’s no cash to renovate it, so it will be sold in “as
is” condition. The market in Regina is also soft, and the average home
price is down slightly from 2014. Joshua hopes to at least get his down
payment back, and their financial situation should improve when his
wife returns to work as a massage therapist. “We’ll be able to really
hack away at our debt,” he says, “but it’s going to take years.”
While real estate has led to financial distress for some Canadians,
it’s been a saviour for others. The home equity line of credit has
allowed millions of households to borrow against their properties,
providing cash for everything from renovations to investing to debt
consolidation. HELOCs have been around in Canada since the 1970s, but
in the mid-1990s, lenders started marketing them to a wider swath of
consumers. Between 2000 and 2010, HELOC balances soared from $35
billion to $186 billion, according to the Financial Consumer Agency of
Canada, an average annual growth rate of 20 per cent.
The pace of growth has slowed since then, but balances still hit $211
billion last year. Lenders have been all too eager to dole out HELOCs,
creating the perception of instant, easy money. An animated commercial
for Alpine Credits, a lender in B.C., features a room full of employees
rubber-stamping loans—even for a client who wants to install a
four-storey waterslide. (The employees celebrate by cheering while one
pops open champagne and another tears off his shirt.)
One common use of HELOCs is to pay off higher-interest debt. Last year,
according to Scotiabank, Canadians used $11.6 billion (or 28 per cent
of HELOC withdrawals) for debt consolidation. Doug Hoyes, a founder of
licensed insolvency trustee Hoyes, Michalos & Associates, has
witnessed the shift. The firm has offices across Ontario and in 2011,
roughly one-third of the firm’s clients owned a home when they filed
for bankruptcy or a consumer proposal. Last August, just six per cent
of insolvent consumers were homeowners. “You don’t need to file a
proposal to pay off your debt,” he says. “You just go out and get a
second mortgage.”
If the pace of home price appreciation slows down—or worse, prices
drop—there will be consequences for households that have been piling on
debt. The slowdown in the southwestern Ontario real estate market is
already creating stress. Hoyes recently saw a couple who purchased a
home four years ago and accumulated $70,000 in unsecured debt. They
bought furniture, hired landscapers and borrowed to finance a swimming
pool. Before the slowdown, the couple might have earned $100,000 by
selling their home. Now they might get $70,000, which would barely
cover their debts. They’re also reluctant to sell and move to a
different neighbourhood. And because of the softening in the market,
they haven’t been able to find a lender willing to issue them a HELOC
large enough to cover their unsecured debt. Their solution? Convince
one set of parents to take out a second mortgage, and borrow from them.
“It’s the bank of mom and dad,” Hoyes says.
And while debt consolidation is an effective strategy if consumers
don’t fall back on bad habits, Terrio says recidivism is a problem.
“They go ka-ching out of their house and pay off their credit card
debts, but they go and run up their cards again,” he says.
Borrowing against her home wasn’t enough for Charis Sweet-Speiss to
pull herself out of debt. A registered nurse, she divorced and moved
from Ottawa to Oliver, B.C., a town south of Kelowna, in 1998. Her
then-boyfriend (now husband) wasn’t working at the time, and the couple
used the divorce settlement to start building a new life; they bought a
used car, a place to live and furniture. “Then that money was gone, so
I just started using credit cards,” she says. “And it was so easy.”
Their debt started building, and their income wasn’t sufficient to pay
more than the minimum. New credit cards she’d never asked for arrived
in the mail, and Sweet-Speiss started using them. She had 13 on the go
at once, and eventually they were all maxed out. “I’ve always been
employed. I make a good salary. But just paying the minimum every month
was a lot of money,” she says. Every six months, she phoned each credit
card company to wheedle them into reducing her interest rate. She
caught some breaks, but never enough to make a big difference: “It was
a horrible way to live.”
Sweet-Speiss says she wasn’t frivolous with her spending, but in
retrospect, she made questionable decisions. When her daughter would
run up a large balance on her own credit card, Sweet-Speiss sent her
money—even though it meant sinking deeper into debt herself.
Sweet-Speiss borrowed against her home at one point and withdrew money
on two separate occasions to consolidate her debt, but was still left
with $40,000 on her cards, and it built up again.
After more than a decade of amassing debt, Sweet-Speiss turned to the
Credit Counselling Society for help ridding herself of nearly $67,000
spread across 13 cards. Once enrolled, her interest payments stopped
and she was put on a plan to pay down principal. She completed the
program this year. She still has a mortgage and a line of credit, but
is finally free of high-interest credit card debt.
Sweet-Speiss says her mortgage would have been paid off a decade ago
had she never borrowed against her house. Indeed, one of the problems
with home-equity loans is that they cause debt persistence. HELOCs are
marketed with little or no obligation to repay in a timely manner. For
years, one of the main advantages of owning a home is the forced saving
effect—paying the mortgage, combined with rising property values,
builds equity. A HELOC undermines that dynamic, tempting consumers to
access cash now rather than build wealth over the long term.
It marks a fundamental shift in the way Canadians think about
homeownership. “Whatever happened to getting to the end of a mortgage
and owning your home?” says Gilbertson, the trustee in Vancouver. “It’s
less about truly owning our homes today and more about having another
revenue stream to fund our lifestyles.”
That Canadians are carrying record amounts of debt is not in dispute.
But the magnitude of the problem is contested. “I think the fears are
overstated,” says Paul Taylor, CEO of Mortgage Professionals Canada.
“Canadians are incredibly prudent, and history will show that.” As the
head of an industry association for mortgage lenders, brokers and
insurers, Taylor isn’t exactly impartial on the issue. But he points to
a report from the Parliamentary Budget Officer released earlier this
year showing that, since 2009, the debt service ratio—a measure of
income spent to pay debt—has remained steady at around 14 per cent, not
much higher than the long-term average. That’s a sign that even though
we have more debt than 20 years ago, we’re not overextending ourselves,
Taylor says.
But the same PBO report projects the debt service ratio will rise to an
all-time high of 16.3 per cent by the end of 2021. Taylor says the
premise is a “little bit flawed” because it presumes Canadians will
make no changes to their finances owing to higher interest rates. “I’m
certain people will become prudent again to ensure they retain that
[historical] expense ratio,” he says. Already, brokers have been
fielding calls from Canadians about locking in their mortgages to guard
against future increases, for example.
Bank of Montreal chief economist Douglas Porter also contends that too
much emphasis is placed on the debt-to-income ratio. “We have long been
of the view that much of the commentary on this topic has been
overwrought,” he wrote in a research note this month. The savings rate
is close to the 25-year average of five per cent, which doesn’t point
to a consumer debt apocalypse. Rather, Porter expects spending to
“gradually moderate” as borrowing costs rise.
Still, numerous surveys show Canadians are worryingly close to the
edge. A report from MNP Ltd., an insolvency trustee, released in
October found 42 per cent of Canadians said they don’t think they can
cover basic expenses over the next year without going deeper into debt.
An earlier survey this summer found 77 per cent of respondents would
have trouble absorbing an additional $130 per month in interest
payments. And as organizations such as the IMF and the OECD have
constantly warned, high household debt renders the country far more
vulnerable to economic shocks.
When a downturn does hit, even a high income won’t necessarily provide
enough protection. Gene moved from the U.S. to Calgary 12 years ago to
take a job with a major oil company, earning more than $300,000
annually. He purchased a home for close to $1 million and supported his
wife, two kids and mother-in-law. In 2015, Gene lost his job when the
price of oil crashed, and was out of work for nine months. He took out
a home equity loan for $30,000 to make ends meet, and eventually found
another job at a pipeline company, but for half his previous salary. A
six-figure income would be more than enough for most Canadians, but Gene
and his family were accustomed to their lifestyle. The kids were
enrolled in extracurricular activities, and housing costs added up to
$4,100 every month.
A year later, Gene was laid off again. “It was just devastating for
us,” he says, adding that he began questioning his self-worth if he was
unable to provide for his family. He eventually found another job, but
at a still smaller salary. On top of the mortgage and the line of
credit, Gene had another $20,000 loan. When he first purchased his
house, he didn’t quite hit the 20 per cent down payment threshold; his
bank offered him a loan to cover the difference. He had a couple
thousand in credit card debt and a small, high-interest loan from
EasyFinancial he’d taken to cover an unexpected medical expense for a
family member. Finally, he faced a $90,000 tax bill, since he opted not
to pay after he lost his job. Gene sought help from an insolvency
trustee earlier this year. “I just wasn’t making enough money, and I
had to protect the family,” he says. Gene submitted a consumer
proposal, but one of his creditors rejected the terms. In October, Gene
filed for bankruptcy—just over two years after making a salary most
Canadians can only dream of.
This sort of precariousness worries some experts, who fear wider
implications for the Canadian economy. “We continue to see the
household sector as accident-prone, with a complacency toward debt
which could prove disruptive to the economy,” wrote HSBC Canada’s chief
economist recently. The result is Canada is at “some risk” of a balance
sheet recession—a period of slow growth or decline caused by consumers
saving and paying down debt rather than spending. David Madani, an
economist with Capital Economics in Toronto, doubts the growth Canada
has seen in exports recently will be enough to offset the decline in
consumer spending. “Canadian policy-makers have allowed household debt
to rise above the disturbingly high levels reached in the U.S. in 2007,
raising the risk of a similar potentially disastrous deleveraging down
the road,” Madani wrote.
Statements like that could be dismissed as fear-mongering, but the
reality is Canada hasn’t been in this situation before, and the outcome
is impossible to predict. Canadians ignored warnings from policymakers
about piling on debt for years because low interest rates were too
enticing. Now households will have no choice but to dial it back. The
only question is how bad the fallout will be.
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