In 2022, the Office of the Superintendent of Financial Institutions (OSFI) announced that it would impose stricter restrictions on HELOCs, more specifically, HELOC loans in Canada bundled with traditional mortgages. Under the proposed changes, Canadian homeowners with access to a HELOC will face a reduction in their borrowing power and stricter rules.
If you rely on a HELOC to cover unexpected bills, pay down expensive debts, or finance massive expenditures, it’s crucial to understand how these changes will impact your finances. Similarly, suppose you plan to acquire a mortgage with a HELOC on top. In that case, you’ll want to assess how the new rules affect your borrowing capacity.
In this article, we’ll explain how the upcoming changes will work, what it means for your household’s budget, and how to prepare if your HELOC serves as your financial safety net.
What changes are being implemented to HELOCs?
The OSFI is targeting a loan product known as a re-advanceable mortgage, which is a type of combined loan plan (CLP). Many of Canada’s top financial institutions offer this mortgage type. Some examples include TD’s Home Equity FlexLine and CIBC’s Home Power Plan.
A re-advanceable mortgage blends a conventional mortgage with a HELOC. It allows you to borrow funds against your home’s equity up to a predetermined limit with flexible repayment terms. As you pay down your mortgage principal, that money becomes available to draw from your HELOC. In other words, your HELOC borrowing power will rise over time as your mortgage shrinks with each monthly payment.
Under the current regulations, you can borrow up to 80% of your home’s value on such a loan, less your mortgage principal.
|Home Value x 80% – Outstanding Mortgage = Maximum HELOC Amount|
|However, your borrowing power will drop to 65% of your home’s value less any traditional mortgage balance under the revised rules. Here’s an example of how this change will impact your HELOC borrowing capacity if you own a home worth $500,000 with an outstanding mortgage of $275,000.|
|Maximum HELOC under the current limit: $500,000 x 80% – $275,000 = $125,000|
|Maximum HELOC under the new limit: $500,000 x 65% – $275,000 = $50,000|
As you can see, it’s a drastic reduction, primarily if you borrow heavily through your HELOC and constantly maintain a large balance.
What happens if you exceed the 65% ceiling after the new rule kicks in? In that case, your lender will force you to start repaying the balance borrowed until your HELOC drops back to 65%.
The 65% threshold will apply to all federally regulated lenders at the end of their fiscal year in 2023. As a result, it officially takes effect either at the end of October or the end of December, 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.
What happens if your HELOC balance exceeds the new limit?
If your HELOC breaches the 65% threshold, you must repay the principal until it falls under this limit. During this point, your HELOC will resemble a regular mortgage as you’ll make fixed payments of interest and principal.
Naturally, this scenario can occur if you borrow too much money through your HELOC. However, it’s also possible if your home’s value drops substantially.
Remember that the HELOC borrowing limit is based on the value of your home. So, a sharp decline in its market price can be enough to push you above the 65% threshold despite no further borrowing on your part.
Surpassing the 65% borrowing limit poses a significant danger if you’re strapped for cash. You could face severe financial stress and risk losing your home by failing to repay the borrowed excess.
The Bank of Canada estimates that over $200 billion worth of outstanding HELOC credit is above the 65% threshold, as of March 2022.
Why are regulators reducing the credit limit on HELOCs?
So why are regulators clamping down on HELOCs suddenly, given how popular they are with homeowners?
The answer is simple: it wants to ensure borrowers can handle their loan payment obligations and that financial institutions don’t expose themselves to excessive risk by lending too freely.
The Canadian housing market is vulnerable due to stubbornly high home prices and steep interest rates at the moment. A wave of defaults on HELOCs and mortgages could devastate the economy, which the OFSI wants to prevent.
The risks of a HELOC for borrowers
HELOCs have many features that make them attractive to borrowers: flexible repayment options (including the ability to make interest-only payments for an extended period), a generous credit limit, easy access to funds, lower rates than credit cards, and no financial penalties for prepayments.
However, those same benefits can lead to severe financial stress for households.
- Temptation to overspend. If you borrow more than you can afford to repay, you risk becoming overwhelmed by debt. Should you fall behind on your payments, your credit score will decline.
- Variable interest rates. The interest rate attached to your HELOC will fluctuate based on changes in your lender’s prime rate. Should rates increase, so too will your monthly payment.
- Callable loan. Your lender may be able to legally demand that you pay your entire balance owed at any time dependant on the terms of the HELOC agreement.
- Modifiable terms and conditions. Your lender can decrease your credit limit at their discretion.
- Home repossession. If you default on your payments, your lender has the right to seize your property through foreclosure or a power of sale.
Given the tremendous risk HELOCs pose to borrowers, it’s understandable why the OSFI is keen to impose stricter borrowing limits.
The risk of a HELOC for lenders
An overreliance on HELOCs by homeowners amplifies the risk for lenders who issue them. Many Canadians today struggle to repay debts, given soaring living costs and high interest rates. As a result, lenders could incur staggering losses if a large portion of the loans they issue go unpaid. A massive banking crisis could even ensue, much like the Great Recession in 2008.
What the new HELOC rules mean for you as a homeowner and borrower
If a HELOC plays a critical role in your finances, it’s important to understand the implications of the upcoming regulations by the OSFI.
Under the new HELOC rules, you’ll have more restricitive access to the equity in your home. Whether this will harm your household’s financial picture depends on how much you borrow through your HELOC and how you intend to use the funds.
Let’s say that you primarily use the money for discretionary purchases. In that case, you must prepare to curb your spending habits. Assuming you’re disciplined and don’t fill the gap with credit cards, which come with higher interest rates than a HELOC, you’re unlikely to experience many financial issues.
If you aim to use the funds for a home renovation, a college program, or a business venture, you may need to postpone your plans. The reason is that few credit sources can give you access to a large sum of money at the interest rate that a HELOC can. Yes, you can supplement your financing from other sources, like a personal loan. But remember that a personal loan requires fixed payments, so it’s less flexible than a HELOC. And if it’s unsecured, you’ll pay a higher interest rate.
Suppose you’re living paycheque to paycheque and rely on a HELOC to cover non-negotiable expenses like utilities and home insurance. In that case, you could face more financial distress, as you’ll need to turn to high-interest debt alternatives like credit cards and payday loans to get by. The same applies to unexpected costs like emergency medical bills or vehicle repairs.
What if you use your HELOC to pay down high-interest, unsecured debts you owe, like credit cards? In that case, you won’t be able to consolidate as much of your obligations as previously thought. Finding an alternative loan that offers similar rates to a HELOC could prove challenging. As a result, you risk getting stuck with more costly debts for a longer period.
How to prepare for the coming HELOC restrictions
If you use your HELOC sparingly, the tighter borrowing restrictions won’t impact you as much, so you can rest easy for the most part.
However, what if you tap into your HELOC to pay off high-interest debt, fund significant one-time expenses, or cover your daily living costs? In that case, you could face some tough financial decisions as your borrowing power shrinks. Therefore, it’s important to review your spending patterns and update your financial plan accordingly. Here are some tips to get you started:
- As your mortgage renewal date nears, negotiate with your lender for a lower rate to keep your interest cost low. Consider transferring your re-advance mortgage to another lender if you can get a better deal.
- If your HELOC is above the upcoming 65% borrowing limit, immediately pay down the balance as much as possible. Employ wise debt reduction strategies to avoid falling into a debt spiral.
- Choose debt alternatives wisely. For example, an unsecured line of credit is usually cheaper than a credit card and offers more flexible payment terms.
- Consider transferring some of your unsecured debts to a balance transfer credit card.
- Postpone or revise your plan for a costly expenditure, such as a home renovation or down payment on a car.
- Improve your credit score to qualify for more loan products at favourable interest rates besides a HELOC.
- Make prepayment against your mortgage to increase your home equity , boosting your HELOC borrowing power in the process.
With regulators increasingly ratcheting down on easy money, it’s crucial to get your debts under control as soon as possible. A HELOC will no longer be the financial safety net it once was for those needing an emergency loan to cover past-due bills or pay off mounting credit card debt.
If your debts are causing you immense grief and you’re unsure how to resolve them, remember that you have many debt relief options available in Canada. With the right strategy, you can eliminate or drastically reduce what you owe and set yourself up for a prosperous future.