PUBLISHED NOVEMBER 7, 2018UPDATED NOVEMBER 8, 2018
Got a home-equity line of credit (HELOC)?
Want to get a new mortgage?
Lenders are about to make your life harder.
Canada’s No. 1 player in HELOCs, Toronto-Dominion Bank, just changed a key policy on Tuesday.
For people applying for a separate new mortgage and keeping their existing HELOC, TD is requiring that applicants prove they can afford a theoretical monthly payment based on the limit – not the outstanding balance – of that HELOC.
TD joins a small number of other lenders, including Royal Bank of Canada, in applying this new policy.
It’s a stealth rule change if there ever was one. As of the time this is being written, the Office of the Superintendent of Financial Institutions (OSFI), Canada’s banking regulator, hasn’t explicitly claimed responsibility for it.
Without a doubt, this could incrementally depress the cottage, second-home and rental markets. We’re not talking a market crash, here, but every credit-policy tightening adds up and weighs on home prices.
Here’s who it affects
If you are getting a new HELOC, all the banks will “stress test” you on the HELOC credit limit. In other words, they’ll add an assumed payment to your mortgage application, based on the greater of the government’s benchmark posted rate (5.34 per cent currently) or the lender’s contract rate plus two percentage points (around 6.45 per cent.) It’s worked like that for a while, so no change there.
If you are merely renewing a mortgage, there is also no impact whatsoever. It’s those people who are getting an additional mortgage and keeping their existing HELOC who get hit.
For an average affected borrower with a $200,000 HELOC, suddenly they’ll have to prove they can afford a $1,202 HELOC payment (based on today’s rates). That could drive a typical borrower’s debt ratio above the typical lender’s maximum limits.
Fortunately for many would-be borrowers, very few lenders have applied this policy – yet. By next year, however, I’d bet that all major banks will, as will scores of other lenders that get their funding from big banks.
HELOCs have been growing like the cannabis market. Okay, maybe not that fast, but fast.
But many borrowers never walk into a bank and ask for a HELOC. They are sold a HELOC.
The Financial Consumer Agency of Canada (FCAC) says, “banks reported to FCAC that a readvanceable mortgage [a mortgage linked to a HELOC] is now the default option offered to credit-worthy mortgage customers with down payments of at least 20 per cent.”
You see, HELOCs not only increase bank profits, they build fences around borrowers at renewal. That’s because borrowers must usually pay more to switch lenders if they have a “collateral charge” – another word for a HELOC.
Lenders often try to approve borrowers for the maximum amount, says broker Shawn Stillman, of Mortgage Outlet. “Banks have been pushing HELOCs for years,” he says. (To be fair, a lot of brokers push HELOCs, too.)
“It’s very hypocritical that banks have been promoting lines of credit and telling people, “Don’t worry, this big HELOC will never impact you. And now the banks are changing the rules of the game…"
Better safe than sorry
Regardless of what banks have been doing, they’re now doing the right thing, many argue. And OSFI would likely agree. On Tuesday, it said in an e-mail to me:
“When underwriting any loan application where the borrower has an existing HELOC in place, FRFIs (federally regulated financial institutions) may use either the limit, or outstanding balance of the HELOC, to estimate an ‘assumed payment’ in calculating the Total Debt Service Ratio (TDSR) for this loan application. It is at their discretion, however OSFI expects that, given the revolving nature of a HELOC facility, FRFIs will take a longer term (and conservative) view of the borrower’s debt servicing requirements.”
In announcing these changes in HELOC policy, TD says its “debt service ratio change was made to ensure prudent underwriting guidelines and reflects concerns around consumers’ abilities to manage debt – particularly in a fluctuating rate environment.”
So, it’s understandable why this is happening, the fallout for those affected notwithstanding. There will be side effects. People with HELOCs who want to buy another property will have to:· Find a lender that doesn’t apply this policy (at a potentially higher interest rate);
· Reduce their HELOC limit in order to pass the stress test;
· Lock in their HELOC to a regular amortizing mortgage – not ideal if the borrower wants to pay off that debt without penalty and easily (and quickly) re-borrow for future needs;
· Close their HELOC.
If you’re thinking about getting a second property and want to retain your HELOC, act before year-end. But don’t get more financing than you can afford simply because of this new rule. Otherwise, you’ll be the person that regulators may be targeting with this policy.