A homebuyer's priced guide to falling real estate prices and rising mortgage rates

Canadian banking regulator tightens HELOC mortgage rules to curb rising homeowner debt

Homes for sale in a new subdivision in Airdrie, Alta. , Friday, January 28, 2022. The Canadian Real Estate Association says the pace of home sales slowed in April as mortgage rates rose.Jeff McIntosh/The Canadian Press

The more fashionable type of real estate equity line of credit is in the crossfire of the Canadian banking regulator, which is looking to curb risky borrowing as higher interest rates put additional pressure on debt-laden homeowners.

The product under scrutiny is a changeover mortgage – a traditional mortgage with a line of credit that increases in size when the customer pays off the mortgage principal. The regulator, the Office of the Superintendent of Financial Institutions (OSFI), calls them Common Mortgage Loan Programs, or “CLPs,” and has been watching with caution as they spread wildly while home prices soared.

In the first two years of the COVID-19 pandemic, convertible mortgage loans increased 34 percent and total loan products were valued at $737 billion in the first quarter of 2022, according to Bank of Canada data. That accounted for 42 percent of all secured home lending, up from 37 percent in the first quarter of 2020 and 36.5 percent in the same period in 2019.

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This sharp increase caught the attention of OSFI. In a January speech, Superintendent Peter Routledge said that changeable mortgages now make up “a significant portion of Canada’s uninsured mortgage debt.” While acknowledging that they can be useful financial tools when used responsibly, Mr Routledge said they “can also create vulnerabilities” for the financial system and increase “the risk of loss for lenders”.

OSFI said it will announce changes to the rules governing these products this spring, and identified two key concerns. One is that the ability to borrow equity from the home after each principal payment has the potential to keep clients mired in debt.

The other is that HELOCs can be used to mask cash flow problems that a borrower may face, making it difficult for lenders and regulators to spot looming problems, especially in times of crisis.

In a speech last November, Mr. Routledge hinted that OSFI could force banks to classify convertible mortgages as riskier loans, which would make it more expensive for lenders to stay on their books as they would have to allocate more capital to each loan. . He also said the regulator might tighten rules on how lenders guarantee these loans.

Bankers and mortgage industry experts say the regulator could also rein in restrictions on how much homeowners can borrow against their homes, or force them to requalify increases for their HELOC.

These changes may help reduce some of the riskier borrowing, but it is not clear that they will slow demand significantly. Experts say banks are likely to pass on higher capital costs for those mortgages by charging customers higher interest rates.

“This will raise costs for lenders, in which case the pricing strategy for these types of products must be recalculated for all lenders,” said Maxim Stenser, director of real estate lobbying group Mortgage Professionals Canada. “If there were more costs involved in manufacturing and maintaining that product, it would become more expensive to provide it to customers, so customers are likely to be affected by it.”

Refinance mortgages are now a staple product for most major lenders. Banks are offering it as a powerful borrowing tool that allows customers easy access to equity in their homes.

A website promoting the Bank of Montreal homeowner’s ready-made line puts the concept of a rehabilitable mortgage succinctly: “Apply once. Borrow some. Pay off some. Borrow again. Pay off your mortgage. Borrow more.”

Other banks have branded their rehabilitable mortgage loans with overburdened names such as TD’s Home Equity FlexLine and CIBC’s Home Power Plan. Spokespersons for Canada’s five largest banks declined to specify the percentage of total mortgage loans these products represented.

But regulators say the products also risk allowing customers to spend beyond their means and build up persistent debt that could make them more vulnerable in the event of an economic downturn.

With national home prices soaring late last year, Routledge said in November that the ability of convertible mortgages to give homeowners more of their borrowing “may at the same time feed and help Canadians withstand rising home appraisals.” This is because homeowners can borrow based on lines of credit tied to their existing homes to purchase vacation properties and investments.

Today, the housing market has seen a severe cold due to rising mortgage rates. Economists predict that the price of the typical home in Canada could fall by double proportions this year.

This will lower the value of the homeowner’s holdings relative to the size of the mortgage and push them closer to the level of debt that OSFI considers troublesome: borrowers who owe their lender more than 65 percent of the home’s value, also known as the loan-to-value (LTV) ratio, a key metric It is used to assess risks in the financial system. A higher ratio represents a higher level of indebtedness that can cause more problems for the financial system.

“This subgroup of borrowers who owe more than 65 percent of LTV poses the greatest risk,” OSFI spokeswoman Carol Sindon said in an email this week.

According to Bank of Canada data, borrowers above this threshold accounted for 28 percent of outstanding consolidated mortgage loans in the first quarter of this year. In the first quarter of 2020, it was 42 percent.

It is not clear whether the level of subprime borrowing has been reduced because home prices have risen dramatically, or because borrowers have been withdrawing small amounts of their HELOCs.

Regardless, as home prices begin to fall, lower prices will put upward pressure on homeowners’ LTV ratios.

“It is important to note that these numbers are based on the current market value of homes and are subject to change as the market moves,” said Ms. Seindon. “If home prices fall from those peak levels, we expect the current permanent value of the real estate sector and the portion above 65 percent to increase as well.”

This means that borrowers may suddenly find themselves at a much higher rate. If they breach the 65 percent permanent value threshold on the HELOC portion of their syndicated loan, they will have to start paying off a portion of the HELOC’s principal. For borrowers who have been over-exploited, this can wreak havoc on their finances.

Most HELOCs only require customers to pay the accrued interest, not the principal of the loan. Because the loans are secured against the borrower’s home, they usually carry lower interest rates than unsecured debt.

One of the reasons banks want to offer rehabilitable mortgage loans is that they make consumers less likely to turn to a competitor. It’s easy to allocate a traditional mortgage from one bank to another, but the CLP must be fully discharged from one of the lenders and re-registered with the new bank. This process requires the borrower to pay the fees and go through administrative hassles.

It is not clear whether these loans combined pose an imminent risk to the financial system. Bank of Canada data shows that a large percentage of clients have relatively low levels of debt. As of the first quarter of this year, 41 percent of syndicated loan borrowers had long-term value at or below 50 percent.

Mortgage industry says OSFI is overreacting. They say HELOCs give borrowers easy access to equity in their homes at a lower interest rate than other loans such as credit cards, personal lines of credit and payday loans.

HELOCs are commonly used for home renovations, rental property investments, to accumulate more expensive credit card debt at low interest rates, as well as a source of emergency funds if the borrower needs a quick cash infusion.

For example, if a borrower loses their job and no longer has a job income to pay their mortgage, relying on a HELOC may be a temporary, low-cost measure to make mortgage payments while looking for another source of income.

HELOCs prevent many more defaults than they cause. The reason is simple. “When times get tough and you don’t have spare cash, changeable mortgages allow you to continue paying your mortgage,” said Robert McCallister, mortgage broker and strategist.

What regulators worry about is when temporary measures turn into permanent solutions – a cycle of borrowing that Canada’s Consumer Financial Agency has described as a “home equity debt spiral”.

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2022-05-19 10:00:00

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