For those wondering if we will ever be the same after the pandemic, signs of normalcy can be found in the latest numbers on debt.
We’re ramping up our borrowing again, just like in the low interest-rate years preceding the pandemic. Note the disconnect. Rates today are rising in a fast and furious way, which makes it a bad time to add to your debt.
A new report by the credit-monitoring company TransUnion says the total amount owing on mortgages, loans, lines of credit and credit cards jumped 9.2 per cent in the first three months of 2022 compared with the same period last year and 13.8 per cent over the first quarter of 2020.
This uptick in borrowing is a result of a much stronger economy and job market. That, and the banks getting aggressive in selling clients on borrowing. A word of advice on banks and credit: Their focus is on building revenue and profit, not what’s best for you and your finances. The right move on debt today is to reduce it.
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TransUnion said the number of new lines of credit opened was up 47.5 per cent in the first quarter compared with last year, while the number of new credit-card accounts jumped 24.6 per cent. Over all, new accounts for all types of borrowing were up 12 per cent.
Worried about the economy, many borrowers paid down their debts in the pandemic. And lenders themselves decided to throttle back on offering new credit in order to limit the potential for losses if the economy worsened. TransUnion research director Matt Fabian said lenders are now rebooting their business.
“They’ve turned on their acquisition engines and they’re trying to recover a lot of that lost growth,” Mr. Fabian said.
Growth in the number of home equity lines of credit is logical in light of the huge gains in home equity over the past two years. With rates often set at 0.5 of a percentage point over the banking sector’s prime rate, currently 3.7 per cent, HELOCs are the most cost-effective way to borrow for expenses it will take a year or two at the most to repay.
You can also pay just interest owed every month if you want.
The drawback with HELOCs is that their rate changes with the prime, which in turn takes its cue from the Bank of Canada’s overnight rate, which is now 1.5 per cent. This benchmark rate has jumped from 0.25 per cent so far in 2022 and could get up to 3 per cent by year’s end.
This becomes an issue 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 credit lines not secured by homes. You could say this is the worst year in decades to get started with a HELOC.
The TransUnion report shows credit cards are a big growth area in lending right now, particularly among Gen Z and millennials. Twenty years ago, a focus on youth by banks might have been criticized as predatory. Today, we need a more nuanced approach. Credit cards are both an e-commerce necessity and a vital way to build a good credit score. Once mainly a tool for lenders to assess borrowers, credit scores are now consulted by landlords, insurance companies and employers.
But credit cards are easily abused, and the penalty for that is an interest rate around 20 per cent in most cases.
Mr. Fabian said payment shock is mostly caused by floating rate debt, such as HELOCs and variable-rate mortgages. “You might say, I’m not losing my house – I’m making my mortgage payment. But what I’m also going to do is not pay as much on my credit card.”
The risk of payment shock suggests now’s not a great time to increase spending on your credit card in a big way. Meantime, the banks are also trying to grow their card business by offering people balance increases. Mr. Fabian said it’s typical consumer behaviour to make use of at least a small portion of a balance increase.
He also noted that in Canada, you have to approve a balance increase from your bank. Right now, taking a pass sounds like a great idea.
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.
Rob Carrick