Over-leveraged homeowners still vulnerable to lenders

The long-awaited federal crackdown on a new mortgage product that is plunging over-leveraged homeowners into debt has fizzled out.

The product is called a Rehabilitable Mortgage. It combines a traditional mortgage and a revolving line of credit that increases in size when the homeowner pays the principal. They are allowed to re-borrow immediately, even when the total loan amount exceeds the 65 percent limit of the appraised value of the home.

Including the amortized portion, homeowners can borrow up to 80 percent of their home’s value, minus any debt owed on the original mortgage.

This week, Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), acknowledged the risk of homeowners in ongoing debt and would require borrowers to pay both the principal and interest on any syndicated loan amount over 65 percent of the home’s value beginning in late 2023.

“After years of warning policymakers about the dangers of HELOCs, this is what we get?” said mortgage expert Robert McCallister, who described the move as “illogical.”

He said homeowners would still be able to borrow up to 80 percent of the value of their homes through frequent use of mortgages.

“As long as they qualify, they can refinance and keep debt accumulation up to 80 percent indefinitely,” McCallister said, adding that the change is more aimed at protecting lenders.

“The reason OSFI is not doing more is simple. In general, the HELOC risk is a low tail risk, rather than a clear and present risk to the financial system,” he said.

This means that with the Bank of Canada raising its benchmark interest rate to combat inflation, Canadians who continue to use their homes for money could be left with only 20 per cent of the property in perpetuity.

To make matters worse, high borrowing rates have left the housing market in a virtual freeze and home values ​​plummeting. Technically, lenders may require a partial repayment if the newly appraised home falls below the value needed to cover the amount owed.

The interest rate on HELOCs is usually linked to the prime lending rate at most banks and the difference can be negotiated. However, if the rate is variable, the capital will be more sensitive to an increase in interest rates. In some cases, a lender will offer fixed-term equity mortgage loans over different time periods like a conventional mortgage, but HELOC rates remain subject to higher interest rates whether or not the principal grows.

Assuming a 3 percent increase in the central bank rate over the course of this year, which is now fully priced, Hillock’s rates would rise from 2.95 percent to about 5.95 percent, according to McAllister.

He said interest payments on $100,000 of Hillock’s debt could at least double from about $246 a month to $496 a month.

A new survey from BNN Bloomberg and RATESDOTCA has provided insight into just how vulnerable some Canadian families are. It found that 58 percent of homeowners with a HELOC currently have an outstanding balance. Most said they borrowed less than $50,000; 10 percent said they had borrowed between $50,000 and $100,000, and 10 percent said they had borrowed more than $100,000.

Balances of at least $50,000 were more common among those 55 and older, indicating that there will be little inheritance for beneficiaries when homeowners move in.

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