In recent years, Home Equity Lines of Credit (HELOCs) have become increasingly popular among Canadian homeowners as a flexible and convenient way to access home equity for various purposes, from renovations to debt consolidation. Tighter restrictions implemented by financial regulators, however, have altered the landscape of HELOCs, prompting homeowners to reassess their borrowing strategies and financial goals. Understanding these changes and their implications is crucial for homeowners considering or currently utilizing HELOCs. In this article, we discuss HELOCs and share what the tighter restrictions mean for you.
What is a HELOC?
A HELOC is a type of revolving credit that allows homeowners to borrow against the equity they have built up in their property. Essentially, a HELOC provides homeowners with a flexible and convenient way to access funds by using their home as collateral. Unlike a traditional mortgage or loan, where the borrower receives a lump sum upfront, a HELOC operates more like a credit card, enabling homeowners to borrow funds as needed, up to a predetermined credit limit. Interest is only charged on the amount borrowed, and borrowers have the flexibility to repay and redraw funds as desired during the draw period, typically ranging from five to ten years. HELOCs can be used for various purposes, including home renovations, debt consolidation, education expenses, or unexpected financial emergencies.
What are the pros of a HELOC?
There are a number of benefits of a HELOC:
- Lower interest rates – while mortgage rates have escalated in the last couple of years, HELOC rates are typically lower than those on credit cards and personal loans. HELOCs can therefore be a cheaper way to consolidate debt or finance a home renovation.
- Flexibility – HELOCs enable you to use the funds as and when you need them. You only need to repay what you borrowed, as well as the accompanying interest. You can access your HELOC funds in a number of ways, and some lenders permit you to convert all or some of your HELOC balance to a fixed rate so you don’t risk facing a higher interest later down the line.
- Potential tax deduction – you’re able to deduct interest paid on a HELOC if you use the funds for home renovations and improve your property.
- Potential credit score improvement – adding a HELOC to your credit history and making your payments on time can help to boost your overall credit score.
- You can borrow a large amount – HELOCs are generally intended for at least five figures, and you can typically borrow up to 80% of the equity in your property.
What are the cons of a HELOC?
There are a number of disadvantages of a HELOC:
- Rates are variable – where home equity loans usually have a fixed interest rate, the interest rates of HELOCs are variable. This means that while you might take out a HELOC at a lower rate, it could become much higher when you need to make repayments.
- It could put your home at risk – as a HELOC is a secured loan, your home is used as collateral. This means that if you can’t make your monthly HELOC payments, your house could be on the line.
- Variable equity – when you take out a HELOC, you borrow against your home’s equity. Should your property’s price decline, you could end up owing more than the value of your home.
- A high balance – as many HELOCs allow you to make interest-only payments during the draw period, it’s all too easy to access cash without considering the consequences. If you fall behind on payments, your credit score could be impacted.
- A callable loan – your lender might be able to demand legally that you pay your full balance whenever they want, depending on the terms of your agreement.
- Variable terms and conditions – your lender is able to decrease your credit limit whenever they like.
Given the risks that HELOCs can carry for borrowers, it’s easy to see why the Office of the Superintendent of Financial Institutions (OSFI) was keen to impose stricter borrowing limits.
How have HELOC restrictions changed?
Back in 2022, the OSFI declared changes were coming for HELOCs, with tighter restrictions being imposed. The tighter restrictions would mean that Canadian homeowners could borrow less, and the money that they borrow would face stricter rules. It’s important that Canadians understand the consequences of these new restrictions, how they will work, and what it could mean for your household. Here are the primary changes:
- The OSFI has targeted a loan product called a readvanceable mortgage. It’s a combined loan plan, and Canada’s top financial institutions have been offering this type of mortgage for a while. Readvanceable mortgages blend conventional mortgages with a HELOC.
- This means you can borrow money against your home’s equity up to a predetermined limit. As you reduce your mortgage principal via monthly payments, more money is available to take from your HELOC. Essentially, you can borrow more as your mortgage reduces.
- Previously, you could borrow up to 80% of the value of your home, except for your mortgage principal.
- Under the tighter restrictions, you will only be able to borrow up to 65% of your property’s value, minus any mortgage balance. This is quite a significant drop for the average household. Say, for instance, your property is worth $600,000 with an outstanding mortgage of $300,000. Previously, the maximum HELOC you could borrow would have been $180,000 at 80%. Now, under the new limits of 65%, this would reduce to $90,000. This means that borrowers have access to a smaller portion of their home equity through a HELOC, potentially limiting their borrowing capacity.
Why were these tighter restrictions introduced?
It’s important to understand the rationale behind the tighter restrictions on HELOCs. These measures were introduced by financial regulators to mitigate risks associated with rising household debt levels and overheated housing markets. By imposing stricter eligibility criteria and borrowing limits, regulators aim to safeguard consumers and prevent over borrowing, particularly in the context of uncertain economic conditions. Additionally, the restrictions can also impact the repayment terms and borrowing costs associated with HELOCs. Lenders may implement stricter affordability assessments and underwriting standards to ensure that borrowers can comfortably manage their debt obligations. The Canadian housing market is vulnerable due to high property costs and increased interest rates, and defaults on HELOCs and mortgages could prove devastating for the economy, which the OFSI wants to prevent. As a result, homeowners may encounter more stringent qualification requirements and higher interest rates when applying for a HELOC.
What happens if you already have a HELOC in place?
In this case, your lender will force you to start repaying the balance borrowed until your HELOC drops back to 65%. The 65% threshold applied to all federally regulated lenders at the end of their fiscal year in 2023. As a result, it officially took effect at the end of last year, depending on which institution issued your mortgage. As a borrower, the new HELOC borrowing limit won’t impact you until your mortgage comes up for renewal. Going over the 65% borrowing limit poses a significant risk if you can’t afford to make your repayments. You could face financial difficulty and risk losing your home if you are unable to repay what you borrowed. If you find yourself in this situation, you should contact a Licensed Insolvency Trustee at Spergel as soon as you can. We have over 34 years’ experience of helping Canadians to get their finances back on track, and we can help you too if you’re feeling overwhelmed by a HELOC or mortgage debt.
How to adapt to the tighter HELOC restrictions
Using your HELOC sensibly can mitigate the impact of tighter borrowing restrictions, and offer some security. Yet tapping into your HELOC to address high-interest debt, cover significant expenses, or meet daily living costs may lead to challenging financial decisions as your borrowing capacity diminishes. It’s crucial, therefore, to assess your spending habits and adjust your financial plan accordingly. Here are some suggestions to help:
- As your mortgage renewal approaches, negotiate with your lender for a lower rate to minimize interest expenses. Consider transferring your re-advance mortgage to another lender if this offers you a better deal.
- If your HELOC balance exceeds the upcoming 65% borrowing limit, reduce it as much as possible as quickly as you can. Use debt reduction strategies to avoid falling into a cycle of debt.
- Choose debt alternatives wisely – an unsecured line of credit, for instance, generally offers more favourable terms than a credit card.
- Explore transferring some of your unsecured debts to a balance transfer credit card.
- Reconsider or postpone large expenses, such as home renovations or car down payments.
- Rebuild your credit score to qualify for additional loan products at favourable interest rates, beyond a HELOC.
- Make mortgage prepayments to bolster your home equity, and enhance your HELOC borrowing capacity.
With regulators having tightened lending standards, it’s important to address your debts promptly. A HELOC may no longer serve as the readily available safety net it once did for covering overdue bills or addressing mounting credit card debt. If your debts are overwhelming and you’re not sure what to do, remember that various debt relief options are available in Canada. Licensed Insolvency Trustees are the only professionals in Canada legally able to file all forms of debt relief, making them well placed to advise you on your specific circumstances and recommend an appropriate option. With a well-devised strategy, you can eliminate or significantly reduce your debt and pave the way for a fresh financial future.
HELOCs: what the tighter restrictions mean for you – FAQs
Here are some of the most common questions we receive about HELOCs and the tighter restrictions:
Is there anything you cannot use a HELOC for?
While HELOCs offer flexibility and accessibility, there are limitations on what you can use them for. Typically, HELOC funds can be used for a variety of purposes, including home renovations, debt consolidation, education expenses, or unexpected financial emergencies. However, there are some restrictions on certain uses of HELOC funds. For example, you generally cannot use a HELOC to purchase investment properties, stocks, or other speculative investments. Additionally, using a HELOC for everyday expenses without a clear repayment plan can lead to financial strain and should be approached with caution. It’s essential to review the terms of your HELOC agreement and consult with your lender to ensure compliance with any restrictions on usage.
What is the limit on a HELOC?
The limit on a HELOC is determined by several factors, including the appraised value of your home, the outstanding mortgage balance, and the lender’s policies. Typically, lenders allow homeowners to borrow up to a certain percentage of their home’s appraised value, minus any outstanding mortgage balance. This percentage can vary but is often capped at around 65% of the home’s value. For example, if your home is appraised at $300,000 and you have a remaining mortgage balance of $150,000, you may qualify for a HELOC with a limit of up to $45,000 (65% of $300,000, minus $150,000). However, it’s important to note that lenders may impose additional criteria and assessments to determine the final HELOC limit, such as your credit score, income, and debt-to-income ratio. It’s advisable to consult with your lender to understand the specific terms and conditions of your HELOC agreement and ensure that you borrow responsibly within the established limits.
How does a HELOC affect your mortgage?
Opening a HELOC can affect your mortgage in several ways. Firstly, it increases your overall debt load as you’re essentially taking on additional debt secured by your home’s equity. This can impact your credit score, initially causing a slight dip due to the credit inquiry and new account, and potentially affecting your credit utilization ratio if you maintain high balances on the HELOC relative to the credit limit. Managing both your mortgage and HELOC payments can also become a factor, especially if you consolidate high-interest debt or finance large expenses using the HELOC. Also, if you consider refinancing your primary mortgage, having a HELOC can complicate the process, potentially requiring you to pay off or close the HELOC as part of the refinancing process or factor the HELOC balance into the assessment of your overall debt-to-income ratio. It’s crucial to carefully evaluate your financial goals and ability to manage additional debt before opening a HELOC, seeking advice from a financial advisor or mortgage specialist if needed.
What is the bad side of HELOC?
While a HELOC can provide convenient access to funds, there are potential drawbacks to consider. One of the main risks is that HELOCs are secured by your home equity, meaning that if you fail to make payments, you could risk losing your home through foreclosure or power of sale. Additionally, HELOCs often have variable interest rates, which can fluctuate over time and lead to unpredictable payment amounts. You might also be tempted to overspend or accumulate debt, as the revolving nature of a HELOC allows for continuous borrowing up to the credit limit. This can result in financial strain and difficulty in repaying the borrowed funds, especially if your home’s value decreases or if there are changes to your financial circumstances. Closing costs and fees associated with opening and maintaining a HELOC can also add to the overall cost of borrowing. It’s important to carefully weigh the potential risks and benefits of a HELOC and to borrow responsibly within your means.
HELOCs can still be a valuable financial tool when used responsibly and prudently, but it’s important to consider it very carefully before taking one on. If you’re struggling with debts and can’t make your monthly mortgage payments, the sooner you address it, the better. At Spergel, the ‘get rid of debt’ people, we will review your financial circumstances and help you to find an appropriate debt relief solution – book your free consultation today.