In tough times, banks can take your HELOC safety net away

A home equity line of credit can be an emergency lifeline if you’ve lost your job and need cash fast.

Prepare for the possibility of having that lifeline yanked in one way or another as the pandemic’s effect on the economy deepens. To an extent that will surprise a lot of HELOC holders, banks and other lenders have almost unlimited power to change the terms of these popular borrowing vehicles.

Banks have not focused specifically on HELOCs during the pandemic. But speculation about HELOCs has been growing lately, in part because mass layoffs have raised questions about how people will manage their debt loads. There’s also a sense that economic weakness could lead to declining house prices, which in turn would put pressure on lenders to look critically at their HELOC clients.

HELOCs are actually a smart way to borrow in an emergency – light years better than credit cards. In this low-interest-rate era, plenty of people have dispensed with keeping cash for emergencies in a savings account and instead put their faith in a HELOC. But in a pinch, HELOCs are not like money in the bank.

With HELOCs, you offer your home equity as security and thus get a preferential interest rate. Many are set at the prime rate, currently 2.45 per cent at major banks, plus a small markup of 0.5 to one percentage point. HELOCs let you borrow up to 65 per cent of your home’s value, while the combined debt of your mortgage plus HELOC can go up to 80 per cent of your home value.

Here are some stark facts about HELOCs provided for this column by the federal Financial Consumer Agency of Canada (FCAC), which apply to federally regulated lenders such as banks:

• The interest rate can be increased: Notice must be provided within 30 days when changes are made to the credit agreement.
• Credit limits can be lowered: The new limit can be at or just above the current balance owing on the HELOC, or it can be below the current balance and thus require repayment of the differential amount.
• HELOCs can be recalled: The lender can ask a borrower to repay in full immediately if, for example, the borrower is delinquent on payments, if the borrower experiences an event that endangers their ability to pay or the borrower’s property falls in value to an amount the lender feels is unacceptable.
• Payment terms can be changed: The standard HELOC requires a minimum monthly payment of interest only, but lenders can require a switch to a mortgage-type loan where payments are a blend of principal and interest.

HELOC balances in Canada totalled about $268-billion as of Jan. 31, according to the Office of the Superintendent of Financial Institutions. Canada Mortgage and Housing Corp. figures from mid-2019 show the average HELOC balance was almost $99,000. A couple of years ago, CMHC reported that there were 3.1 million HELOCs, with about one-third of them untapped.

A 2019 survey by the FCAC highlights the extent to which HELOCs were being used as a financial lifeline well before the pandemic.

Just less than half of HELOC borrowers used the money for home renovations, while 22 per cent used it for debt consolidation (using cheap HELOC debt to pay off higher-rate borrowing such as credit cards), 19 per cent to purchase a vehicle and another 19 per cent to cover day-to-day expenses. Another 14 per cent regarded their HELOC borrowing as an emergency fund. (Respondents were asked to choose all uses that applied.)

People in the lending and credit counselling sectors say banks monitor the financial health of customers by keeping tabs on their credit files. A falling credit score and missed payments are warning signs that could prompt lenders to take action on a HELOC.

Be mindful of this if your HELOC has a balance on it. If your bank wants to convert your HELOC to a mortgage, the cost of servicing this debt could rise substantially. If your bank capped your limit at the amount you have already borrowed, you wouldn’t be able to access it to generate cash to pay expenses. Demanding repayment of your HELOC is also possible, though considered less likely because it’s so extreme.

Banks are deferring mortgage payments for as long as six months for clients experiencing financial hardship as a result of the pandemic, but it doesn’t look like similar consideration is available for HELOCs.

Zafar Shah of Montreal went to his bank recently to ask about a deferral of payments on a mortgage and HELOC. “With respect to credit lines, the answer was a big fat no,” he said. The rationale was that HELOCs already allow borrowers to make a minimum interest-only payment each month without repayment of principal.

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