Q: When we bought our home about five years ago, we applied for a home equity line of credit (HELOC) at the same time. It’s an older home in need of renovations so we planned to use the line of credit to finance the renos. Because we haven’t used it much since we took out the mortgage, I contacted our bank and spoke with our lender to make sure we’ve got the money available that we anticipate needing. Good thing I asked. It turns out the rules are changing, and we have less money available than we thought we did. We don’t quite understand what’s going on, but we don’t want to leave ourselves short. What can you suggest? ~Lily
A: The rules in Canada around how much a homeowner can borrow against the equity in their home are in the process of changing for some types of loans. As of the end of this year, all federally regulated financial institutions will need to adhere to a maximum real estate loan of no more than 65 per cent of the declared value of a home when a conventional mortgage is paired with a secured line of credit. Previously, the limit was 80 per cent, so the biggest impact will be felt by those who have a combined loan product and owe more than 65 per cent of the value of their home, as declared when the mortgage was first advanced.
These types of combined real estate loans are often called re-advanceable mortgages because as you pay down the principal of your mortgage, the available credit in the HELOC goes up. For anyone counting on the higher limit of their HELOC to fund additional needs such as renovations, an emergency fund, or to consolidate debt, these new regulations could impact how you manage your money.
The appeal of HELOCs
These lines of credit are a way to tap into your home equity whenever you need your home to lend a hand. Similar to a traditional line of credit, overdraft protection on a bank account, or a credit card, you only pay interest on the money you actually borrow. Minimum payments on a HELOC are typically interest-only calculated at a variable interest rate, based on a lender’s Prime rate. Under this scheme, one of the dangers is that a borrower may only end up repaying the principal balance when the line of credit is closed, such as when they sell their home.
Use of home equity lines of credit grew to record highs with the rise in property values. As the perceived value of someone’s home appreciated, so did their ability to refinance their mortgage loans up to 80 per cent of the market value of their home. However, with a current decrease or levelling off of home values in many markets, consumers already leveraged to the 80 per cent limit could find themselves owing more than their home is worth. Protecting consumers, lenders and the real estate industry is, in part, the motivation behind this latest round of regulatory changes.
What Happens If Your Mortgage is Higher Than the Value of Your Home?
What impact will borrowers feel right away?
Canadians currently holding real estate loans in excess of the new 65 per cent threshold will be advised by their federally regulated financial institution how their loans will be brought into compliance with the new regulations. While each institution will determine how best to serve their clients, it has been generally understood that consumers will not see an increase to their existing required monthly payments.
However, those who choose to obtain a new mortgage combined with a HELOC, port an existing combination mortgage to a new property, or refinance their existing mortgage and line of credit, will be impacted by the new regulations. Reverse mortgages and shared equity mortgage products will experience the change as well.
What to Watch Out for When Consolidating Debt With a HELOC
How to mitigate the impact of tighter lending regulations on your own finances
It can be frightening to think that your credit limits will be decreased, and except under exceptional circumstances, this normally does not happen. It’s important to keep in mind that how much a lender decreases your extended credit is their decision and with notice, they can revoke previously granted limits at any time.
Also be aware that while these rules currently only apply to federally regulated institutions, if you bank at a provincially regulated financial institution, such as a credit union, you may want to inquire with them to see if their internal policies will also be changing.
To prepare for less available credit with your HELOC, reach out to your lender and explore your options. Non-real estate loans don’t face the same regulatory changes. Your lender also has hardship options available due to other recent regulatory changes. Alternatively, you can reach out to your high ratio insurer if you have an insured mortgage and are struggling. Call ahead and make an appointment with your financial institution so that you can review your whole situation with a qualified representative.
Where to Find Mortgage Hardship Help
If you’re unsure how to prepare for an appointment at your bank or credit union, contact a non-profit credit counselling agency in your area. A credit counsellor can review all of your debts as well as your budget with you. They can answer your questions and provide impartial guidance to help you know what to ask when you meet with your lender.
Finally, don’t be afraid to make tough choices if they’ll benefit you in the long run. Look for temporary solutions if you believe that your current financial situation can be rectified within the next year. For example, you could find ways to become a one-car household and pay off your car loan to free up extra cash in your budget. Once you’re back on track, purchase a good used car and reverse your previous decision to sell one car.
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If you feel that it will take longer than a year to get back on track financially, look for longer term solutions to help you regain financial stability. This could mean downsizing your home, building a mortgage helper suite, selling assets, or taking on a second job. To position yourself better for the future, set concrete goals and increase your income and decrease your expenses to establish a new normal.
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If you were counting on the additional HELOC funds for a particular purpose, research other options to meet your goals. For instance, with renos, could a family member with the right credentials and experience show you how to do some of the work yourself? Could friends help you at a reduced cost? Is there a way to source the materials at a better price, such as ordering a larger quantity and share it with a neighbour? Could you break the project up into smaller stages, each stage being funded by some extra work you do to generate surplus income? Rather than bog yourself down with all of the potential drawbacks and obstacles, be creative and focus on solutions instead.
The bottom line on using a HELOC effectively
A home equity line of credit is one tool to accomplish your goals. When used effectively it can provide the funds you need at a traditionally lower interest rate. Flexible repayment terms and the ability to reuse the funds are equally attractive. However, during this time of high living costs, a HELOC can become a crutch, making it easy to remain in debt. If your combined HELOC and mortgage loan total more than 65 per cent of the value of your home at the time you took out the mortgage, speak to your lender about adding the excess balance to your mortgage or obtaining a new appraisal if you believe the value of your home has increased. Due to the new regulations, a rebalancing of real estate loans will occur, so be aware as a lender could calculate a new and higher payment for you. Be proactive; it will help you remain in control of your financial situation and preserve your overall well-being.
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Peta Wales is President and CEO of the Credit Counselling Society, a non-profit organization. For more information about managing your money or debt, contact Peta by email, check nomoredebts.org or call 1-888-527-8999.