Over-indebted homeowners remain vulnerable to lenders
A long-awaited federal crackdown on a new mortgage product that pushes over-indebted homeowners deeper into debt has collapsed.
The product is called a re-advanceable mortgage. It combines a traditional mortgage with a revolving line of credit that increases in size as the homeowner repays the principal. It allows them to re-borrow immediately, even when the total loan exceeds the limit of 65% of the appraised value of the house.
Including the amortized portion, homeowners can borrow up to 80% of the value of their home, less any outstanding debt on the original mortgage.
This week, Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), recognized the risk of having owners in debt and will require borrowers to pay both principal and interest on any combined loan amount greater than 65% of the value of the home from the end of 2023.
“After years of warning policymakers about the risks of HELOCs, here’s what we get?” said mortgage specialist Robert McLister, who called the decision “inconsequential”.
He said homeowners will still be able to borrow up to 80% of their home’s value by repeatedly using forgivable mortgages.
“As long as they are eligible, they can refinance and continue to accumulate debt up to 80% indefinitely,” McLister said, adding that the change is more about protecting lenders.
“The reason OSFI hasn’t done more is simple. Overall, HELOC risk is a tiny tail risk, not a clear and present danger to the financial system,” he said.
This means that as the Bank of Canada aggressively raises its benchmark interest rate to fight inflation, Canadians who continue to dip into their homes for cash could find themselves perpetually owning just 20% of the property.
Worse still, higher borrowing rates have virtually frozen the housing market and home values are falling. Technically, lenders could demand a partial refund if a newly appraised home falls below the required value to cover the amount owed.
The interest rate on HELOCs is usually tied to most banks’ prime rate and the difference can be negotiated. If the rate is variable, however, the principal will be extremely sensitive to interest rate increases. In some cases, a lender will offer fixed-term home loans over different terms, like a conventional mortgage, but HELOC rates remain sensitive to rising interest rates whether or not principal increases.
Assuming a 3% increase in the central bank rate during this year, which is now fully priced in, HELOC rates would rise from 2.95% to around 5.95%, according to McLister.
He said interest payments on $100,000 of HELOC debt could at least double, from about $246 a month to $496 a month.
A new survey from BNN Bloomberg and RATESDOTCA has provided insight into the vulnerability of some Canadian households. It revealed that 58% of owners with a HELOC currently have an outstanding balance. Most said they borrowed less than $50,000; 10% said they had borrowed between $50,000 and $100,000, and 10% said they had borrowed more than $100,000.
Balances of at least $50,000 were more common among people aged 55 and older, suggesting there will be less inheritance for beneficiaries when owners die.