For those wondering if we will ever be the same after the pandemic, signs of normalcy can be found in the latest debt numbers.
We are increasing our borrowing again, just like in the years of low interest rates that preceded the pandemic. Note the disconnect. Today, rates are rising fast and furiously, making it a bad time to add to your debt.
A new report from credit monitoring firm TransUnion says the total amount owed on mortgages, loans, lines of credit and credit cards jumped 9.2% in the first three months of 2022 from the same period last year and 13.8% in the first quarter of 2020.
This increase in borrowing is the result of a much stronger economy and labor market. That, and banks are getting aggressive in selling customers on loans. A word of advice on banks and credit: their goal is to generate income and profit, not what’s best for you and your finances. Today, the right decision to make regarding debt is to reduce it.
HELOCs make us complacent and debt-hungry. They are now a defining Canadian feature
TransUnion said the number of new lines of credit opened increased 47.5% in the first quarter compared to a year ago, while the number of new credit card accounts jumped 24.6%. Overall, new accounts for all loan types increased by 12%.
Worried about the economy, many borrowers have paid off their debts during the pandemic. And the lenders themselves have decided to limit the supply of new credit in order to limit the potential for losses in the event of a deterioration in the economy. TransUnion research director Matt Fabian said lenders are now restarting their business.
“They’ve fired up their acquisition engines and they’re trying to claw back a lot of that lost growth,” Fabian said.
The growth in the number of home equity lines of credit makes sense given the huge gains in home equity over the past two years. With rates often set 0.5 percentage points above the banking industry prime rate, currently at 3.7%, HELOCs are the most cost-effective way to borrow for expenses that will take a year or so. two at most to repay.
You can also pay only the interest due each month if you wish.
The downside to HELOCs is that their rate changes with the prime rate, which in turn is modeled after the Bank of Canada’s overnight rate, which is now 1.5%. This benchmark rate has risen from 0.25% so far in 2022 and could reach 3% by the end of the year.
This becomes a problem if we see a condition that TransUnion calls “payment shock,” which goes hand in hand with rising interest rates and inflation.
Every increase will be felt by people with HELOCs and also unsecured lines of credit from homes. You could say this is the worst year in decades to start with a HELOC.
TransUnion’s report shows that credit cards are currently a major area of lending growth, particularly among Gen Z and Millennials. Twenty years ago, banks’ focus on young people might have been criticized as predatory. Today, we need a more nuanced approach. Credit cards are both a necessity for e-commerce and an essential means of establishing a good credit rating. Once primarily a tool for lenders to assess borrowers, credit scores are now consulted by homeowners, insurance companies and employers.
But credit cards are easily abused, and the penalty for this is an interest rate of around 20% in most cases.
Mr Fabian said the payment shock is mainly caused by variable rate debt, such as HELOCs and variable rate mortgages. “You could say, I’m not losing my house – I’m making my mortgage payment. But what I’m also going to do is pay less on my credit card.
The risk of payment shock suggests that now is not the ideal time to dramatically increase spending on your credit card. In the meantime, banks are also trying to grow their card business by offering people balance boosts. Fabian said it’s typical consumer behavior to use at least a small portion of a balance boost.
He also noted that in Canada, you must approve a balance increase from your bank. Right now grabbing a pass seems like a great idea.
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