Secured Lines of Credit: Financial Flexibility or Major Financial Risk?

The line of credit is therefore a profit-making instrument that accentuates the banking model and often at the expense of the misinformed consumer. ​

Major banks mandate the sale of secured lines of credit because they generate significant annual profits for banks and shareholders. According to Royal Bank of Canada’s 2016 Annual Report, RBC had secured just over $41 Billion of collateralized lines of credit products on real estate across Canada. 

Because a line of credit is an open credit product, it's technically supposed to be used to borrow short-term funds that can be repaid relatively quickly or to provide an interim hedging strategy, for example, and yet, today, many borrowers are stuck making long-term interest-only payments at double the current interest rates, instead. 

According to CIBC’s website, “a line of credit is for you if you want":

• Access to funds on an ongoing basis
• Flexible funds for home renovations, vehicle purchases, daily spending and even consolidating your higher-interest debt
• To pay interest on what you borrow
• Competitive interest rates

A borrower can indeed find all of these claims enticing but that doesn’t mean a line of credit facility remains the best financial product for them or even the wisest for that matter. 

Unfortunately, there is not much research that exists that studies the spending habits via the line of credit after borrowers get approved. There is only anecdotal evidence that can be provided by the professionals who work within the financial industry who can objectively verify the results and who currently work to help borrowers who have found themselves in a hot spot.

For example, some important questions which are often not asked by financial banking representatives include:

• what happens when borrowers max out their line of credit as they often do?
• What happens when they can’t access funds on an ongoing basis because they have dipped into their line to compensate for shortfalls required for living expenses or to spend money which cannot be repaid in a short period of time?
• What happens when a borrower purchases a vehicle on a line of credit and just makes the interest-only payment and instead of owning the vehicle outright like they would have through a closed loan for a set term, they still owe the original balance after years of making payments? 
• And lastly, are secured lines of credit really more competitive when it comes to interest rates? If a closed mortgage term offers an interest rate of 2.64%, for example, over 5 years, is it really more competitive to pay 4.45% (or Prime plus .50%), that is just interest-only on the outstanding balance for 2 to 5 years or more?

When it comes to banks and profits, it’s evident that banks only want to make money and banking representatives are not trained to deliver the vital learning that is required to help borrowers make the best financial decisions.

Unfortunately, many borrowers currently stuck in the line of credit trap haven’t caught on to the fact that the secured line of credit product is often useless if it can’t be repaid in a short period of time (and in most cases it can't) because it will likely transform into an expensive monthly interest-only payment that doesn't pay down mortgage principle in the long-run.

The line of credit is therefore a profit-making instrument that accentuates the banking model and often at the expense of the misinformed consumer. 

In closing, the financial sector is well aware of the dangers lines of credit products expose borrowers to such as “having access to additional credit that doesn’t cost anything until it can be a hard temptation to resist, especially when the interest charges on lines of credit are still low”, the impact of rising interest rates, and the inability to repay the money borrowed. And yet, despite the financial risks to borrowers, they are still sold over and over again to those who don’t fully grasp all of the benefits and disadvantages.

Therefore, if you or someone you know have a line of credit that is currently costing more money than anticipated, we can help. Contact us today. 

Sources:

Rbc.com. (2019). [online] Available at: http://www.rbc.com/investorrelations/pdf/ar_2016_e.pdf [Accessed 9 Nov. 2019].

Personal Line of Credit | Lending | CIBC Cibc.com. (2019). Personal Line of Credit | Lending | CIBC. [online] Available at: https://www.cibc.com/en/personal-banking/loans-and-lines-of-credit/lines-of-credit/personal-line-of-credit.html [Accessed 9 Nov. 2019].

 The hidden dangers of using a line of credit to consolidate debt The Province. (2018). The hidden dangers of using a line of credit to consolidate debt. [online] Available at: https://theprovince.com/opinion/columnists/the-hidden-dangers-of-using-a-line-of-credit-to-consolidate-debt [Accessed 9 Nov. 2019].


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