Home Equity Extraction and Household Spending in Canada

Introduction

Household spending has closely tracked house prices in Canada (Chart 1). When house prices grew sharply in 2016–17, household spending also grew at a robust pace. More recently, house price growth and household spending growth have fallen to levels last seen in 2011.

Household spending and house prices are driven by common forces, including monetary and macroprudential policies, as well as economic conditions. But they also move together because of something called the “collateral effect”: as home values rise, homeowners find it easier to borrow using their home value as security. This increased borrowing is then used, in part, to finance household spending. If this collateral effect is strong, it could leave the economy more vulnerable to adverse events, such as a large decline in house prices. Specifically, if equity extraction contributes meaningfully to household spending in normal times, its absence can exacerbate spending cuts in bad times.

In this note, we measure home equity extraction in Canada and track its evolution over time. We then assess how much it has contributed to household spending in recent years. This analysis uses anonymized credit bureau data from TransUnion (TU), containing account-level information for approximately 25 million credit-active consumers.

Chart 1: Annual growth in household spending and house prices

Equity extraction totalled $89 billion at the peak in 2017

Canadian homeowners can extract equity from their homes in two ways:

  1. Home equity line of credit (HELOC): This is a line of credit secured against the borrower’s home. In Canada, homeowners can access up to 65 percent of the value of their home through a HELOC. But the sum of the outstanding mortgage balance and HELOC must not exceed 80 percent of the value of the home.

  2. Mortgage refinancing: This entails replacing an existing mortgage with a larger one—up to 80 percent of the value of the home. While the TU data do not explicitly document this form of equity extraction, an algorithm was developed to help identify it.

Total equity extraction peaked at $89 billion in 2017. Of this, $49 billion was through HELOCs and $40 billion through mortgage refinancing (Chart 2). Over our period of study, equity extraction through HELOCs has tended to be higher than equity extraction through refinancing, accounting for about 60 percent of total equity extraction, on average. However, the two methods of equity extraction have shared similar dynamics, with a notable rise between 2014 and 2017 and a decline in 2018.

Chart 2: Total equity extraction in Canada

More people use HELOCS, but more equity is extracted through refinancing

To better understand the evolution of equity extraction, it is useful to separate the aggregate dollar amounts into the number of people extracting equity (equity extractors) and the amount of equity extracted.1 Chart 3 shows that both factors have influenced aggregate equity extraction, though there have been sharper movements in the number of equity extractors.

It is also evident that equity extraction through refinancing is much less prevalent than equity extraction through HELOCs. In 2017, about 380,000 mortgagors refinanced their mortgages to take out equity, whereas nearly 2 million homeowners used HELOCs. People who refinance their mortgage, however, tend to take out more equity than those who use HELOCs. For example, the median amount of equity extracted through refinancing was $54,000 in 2017, compared with just $12,000 for those extracting equity through HELOCs. This is intuitive given that HELOCs offer the flexibility to extract available home equity on demand, whereas equity extraction through refinancing is a point-in-time decision typically tied to the renewal schedule of the mortgage (five years, in most cases).

Chart 3: Decomposition of equity extraction

a. Mortgage refinancing

b. HELOCs

Alberta led the increase in equity extraction observed in 2015

An interesting observation from the preceding charts is that the increase in equity extraction predated the housing market strength that began in 2016. To further understand this observation, we look at the number of equity extractors by province (Chart 4).

The 2015 increase in the number of equity extractors is attributable, in part, to increased equity extraction in Alberta. This suggests that the ability to tap into home equity helped buffer the impact of the oil price shock in Alberta, where homeowners had previously benefited from a prolonged rise in house prices.

Also evident is that most of the country saw large increases in the number of equity extractors starting in 2015, suggesting a common factor was at play. Interest rates are a likely candidate given that the Bank of Canada twice lowered the target overnight rate in 2015. Indeed, preliminary analysis suggests equity extraction dynamics have been associated with movements in both interest rates and house prices over our study period.

Chart 4: Number of refinancing equity extractors (2013 = 100)

Household spending would have been materially lower without equity extraction

The TU data can be used to quantify equity extraction, but how this equity is subsequently spent cannot be known for certain. Survey evidence on the uses of home equity can provide a helpful starting point for thinking about how equity extraction relates to household spending.

As shown in Table 1, survey evidence suggests a quarter of extracted equity goes toward consumption, with another quarter funding home renovations.2 Applying these proportions to our estimates of total equity extracted, we can get a sense of how important equity extraction might be for household spending in Canada.

Table 1: Survey evidence on uses of home equity

Uses of home equity Proportion of dollars allocated (%)
Debt consolidation 28
Home renovations 25
Consumption 25
Investments 22

Source: Mortgage Professionals Canada 2013–18

In relating equity extraction to data on aggregate household spending, we must first isolate the relevant spending categories. In the case of consumption, housing equity is most likely to be spent on big ticket items. Therefore, we focus on the consumption of both durable and semi-durable goods, which includes purchases of things such as motor vehicles and furniture. Within residential investment, we focus on renovation spending.

Using the survey-based proportions from Table 1 in conjunction with our estimates derived from anonymized TU data, we find that equity extraction has, on average, accounted for 7 percent of durables and semi-durables consumption and 35 percent of renovation activity over our period of study. These calculations help establish that equity extraction contributes materially to household spending in Canada.

However, a more pertinent question in the current context is not just how important equity extraction is in general, but to what extent it might have contributed to recent household spending dynamics. To help answer this question, we estimate the levels of consumption and renovation spending that would have prevailed had equity extraction not risen after 2013. We then compare the cumulative growth of the officially reported data with these counterfactual measures.

Chart 5 shows that by the end of 2017, increased equity extraction could have added about 2 percent to the level of consumer spending on durables and semi-durables, and 11 percent to the level of spending on renovations. This translates into an impact of about 0.5 percent on the level of gross domestic product (GDP).

In contrast, the 2018 decline in equity extraction could have removed 0.5, 2.5 and 0.1 percent from the levels of consumption (durables and semi-durables), renovations and GDP, respectively.

Chart 5: Contribution of increased equity extraction to components of household spending

Conclusion

Our results establish that equity extraction is economically important in Canada. In particular, we find that increased equity extraction has likely contributed materially to consumption and renovation spending in recent years. In the future, we plan to look more deeply into the characteristics of equity extractors, as well as to undertake econometric analysis of the factors influencing the decision to extract equity.

  1. 1. Related research using US data suggests that the equity-fuelled boom-bust cycle in US consumption mainly reflected changes in the number of equity extractors, as only a small fraction of extracted equity for a given individual was used to finance consumption.[]
  2. 2. Various surveys ask respondents how they use extracted equity. We use the Mortgage Professionals Canada survey in this note because it asks how the dollar values are allocated as opposed to what proportion of respondents took different actions. The category “consumption” is the sum of “purchases” and “other.”[]

Disclaimer

Bank of Canada staff analytical notes are short articles that focus on topical issues relevant to the current economic and financial context, produced independently from the Bank’s Governing Council. This work may support or challenge prevailing policy orthodoxy. Therefore, the views expressed in this note are solely those of the authors and may differ from official Bank of Canada views. No responsibility for them should be attributed to the Bank.

JEL Code(s): D, D1, D12, E, E2, E21, G, G2, G20