Banking on a Home Equity Line of Credit? Think Again!

COVID-19 has spurred Canadian banks to revise their HELOC policies

Over the years, the Home Equity Line of Credit (HELOC) has served as a financial lifeline for many cash-strapped Canadians. Whether it is home improvement expenses, debt consolidation, down payments for children’s education, or other emergency expenses, a HELOC has served to resolve a variety of financial difficulties in the past. However, while Canada and the rest of the world try to cope with the economic impact of the COVID-19 pandemic, there may soon come a time when Canadian banks tighten access to HELOCs, taking away this popular financial safety net.

The federal and provincial governments have rolled out a slew of subsidies and financial assistance measures, including mortgage deferrals to ease the burden on those who have lost their jobs or were forced into early retirement. However, in a few months from now, these programs will start to wind down. In fact, individual provinces have already started rolling out plans to ease the lockdowns, restart their economies, and reopen businesses. Once the coronavirus-linked government assistance programs end, it will further diminish the finances and purchasing power of the already financially stretched borrowers, who may consider tapping into HELOCs.

However, amid the economic uncertainty, banks are re-evaluating their HELOC policies, and considering amendments to their line of credit programs. In order to understand the reasons behind these revisions, let’s take a closer look at how things stand today. As early as mid-April 2020, one bank has already changed some rules for borrowers around using HELOCs as down payments on investment properties, while another bank has stopped accepting new HELOC applications temporarily. So, why is it that North America’s biggest banks are feeling wary about HELOCs?

• Since a vast majority of borrowers are struggling to get by with the government-led assistance schemes, bankers consider them a high-risk group. This group of borrowers could potentially increase the risk of unpaid loans or troubled loans, which can add significant stress to the banks’ balance sheets.
• HELOCs often are cheaper than other loans, since they are secured by the home. Borrowers pay monthly interest only on the amount drawn, continue to build equity in their home, and enjoy easy access to additional credit. Under the current economic circumstances, bankers consider these features as disadvantageous. That is because HELOCs raise the risk of borrowers taking on too much debt, which could eventually turn into a burden for the lending institutions.

If a HELOC is a critical component within your current or future personal finances, it is important to understand:

1. What kind of changes could lenders make to the terms of existing HELOC customers?
2. How will the current circumstances impact future HELOC borrowers?

Potential changes to current and future HELOC terms

A smarter alternative to high-interest credit cards, a HELOC allows you to borrow up to 65% of the value of your home (excluding the balance mortgage amount). If you have no other lien on your home, you could access up to 65% of your home’s value through a HELOC. With this revolving credit arrangement, you continue to enjoy the equity value appreciation for your home, and pay interest only on the amount you draw, as and when you borrow it.

However, as per the Financial Consumer Agency of Canada (FCAC), all federally regulated lending institutions (essentially the Canadian Banks) can make changes to existing HELOC terms, including some significant modifications.

• Interest rates: While HELOC interest rates are often lower than other types of loans, these rates fluctuate based on the prime lending rate (PLR) and individual banks’ markups. As long as the lending bank provides appropriate notice, they can continue to increase the HELOC interest rates. A significant rate hike could put you in a tough spot on the monthly interest payments, and also disrupt your plans for principal repayment.
• Credit limits: Your lending bank has the option to revise your credit limits at any time. Usually the revised limit could be set at, or just above the current balance that you owe on the HELOC, especially in the event of missed payments. As an extreme measure, the banks can revise the limits to below your current balance. In such a scenario, you will be liable to repay the differential between your new approved credit limit and your existing balance within a specified timeline.

For example, you may have an approved HELOC credit limit of $200,000, of which you have utilised 70%, i.e. $140,000.

• If your revised credit limit is $150,000, you can draw an additional $10,000, but no more than that.
• If your bank caps your new credit limit at $140,000, you cannot borrow any more than you already have. You may also be given a fixed timeline to repay the missed payments, and get back on track with paying the minimum monthly interest.
• If your bank revises the limit to $120,000, you will not only have to repay the missed interest payments, but also the differential amount of $20,000 within a defined fixed period.
• Loan recall: Your lender can ask you to repay the HELOC in full, immediately. Usually, such a condition is applied:
  • If you are delinquent
  • If you experience an event that limits or endangers your ability to pay
  • If your property value falls to an amount that the lender feels is unacceptable
• Repayment terms: The standard arrangement for a HELOC requires you to make a minimum monthly payment towards interest alone. The amount and timeline for principal repayment is usually your choice. However, lenders have the power to modify your payment terms and introduce a blend of principal + interest repayment at their discretion, especially if they want to limit their exposure to bad credit.

HELOC is a ‘callable’ debt, which means there is no limit to how the lenders can change the borrowing conditions of your line of credit. As long as they give you sufficient notice, they can bring about significant modifications in the repayment terms of your HELOC. Additionally, they may also consider stricter thresholds and norms to make new HELOCs less accessible to potential borrowers.

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Impact of HELOC changes on existing and future customers

According to the office of the Superintend of Financial Institutions, as of January 2020, HELOC balances in Canada totalled around $268 billion. As per the Canadian Mortgage and Housing Corporation’s Q4 2019 report, the average HELOC balance is around $98,900, with an average utilization of 57%. A 2019 FCAC report on HELOC consumer behaviours shows HELOC utilization to be as follows:

• 49% for home renovations
• 22% for paying off high-interest borrowings, such as credit cards
• 19% for vehicle purchase
• 19% for managing day-to-day household expenses
• 14% for emergency expenses
• Other uses included travel, residential property purchase and financial investments.

(*Since the responders had to choose all uses that applied, the total will not add up to 100%)

Most Canadians are feeling the heat of the current economic realities in some shape or form. As a HELOC customer, no matter how you have utilized your line of credit so far, there is a good chance that you are looking for relief measures or deferrals on the existing repayment terms, including your mortgage payments, if any. Although the federal government urged Canadian banks to introduce mortgage deferral programs for six months for Canadians financially impacted by COVID-19, there is no uniform framework for this subsidy. Every major bank has pledged to support their customers on a case-by-case basis to help them through pay disruption, lack of childcare services, illness-related challenges, and other hardships. However, the terms, processes, eligibility criteria and documentation requirements for each bank are different.

Consider the CHIP Reverse Mortgage® as an alternative to a HELOC

A Home Equity Line of Credit is a low-interest option for accessing the equity in your home. However, missed monthly payments could result in reduced credit limits, and in extreme cases, you could even lose your property.

If you are 55 years or older, you may qualify for tax-free cash thanks to the CHIP Reverse Mortgage. Similar to a HELOC, you can use the loan amount for any kind of expenses; a flexibility that is highly valuable during the uncertainties associated with COVID-19 and beyond. Moreover, you retain ownership and continue to stay in your home, without any obligation to make monthly payments towards the interest or principal amount. The loan becomes due only when you decide to move or sell your home. Canadian retirees who do not have fixed monthly income sources may be better off considering a reverse mortgage, instead of a HELOC.

Explore how the CHIP Reverse Mortgage can serve as a more efficient borrowing option than HELOC. Call us at 1-866-522-2447 today. You can also use our reverse mortgage calculator to see how much tax-free cash you qualify to receive.