Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
Some feared Canada’s banking regulator would put the smackdown on home equity lines of credit (HELOCs) in its long-anticipated regulatory update on Tuesday.
After all, the Office of the Superintendent of Financial Institutions (OSFI), the Financial Consumer Agency of Canada (FCAC) and the Bank of Canada have been warning about HELOC overborrowing for years.
Instead, OSFI put that fear to bed.
OSFI did make one key change, however. It limited the readvanceability of readvanceable mortgages – and that’s going to force some borrowers to make adjustments.
But first, what is a readvanceable mortgage?
A readvanceable mortgage has two or more parts: a regular mortgage portion and a revolving line of credit (LOC). As you pay down the mortgage portion your available credit grows in the LOC.
If, for example, $1,000 of your mortgage payment goes toward the principal, you can promptly reborrow that $1,000 from the LOC.
Today, big banks allow readvanceable mortgages of up to 80 per cent of your home value, as long as the revolving portion is no more than 65 per cent.
Effective late 2023, OSFI’s new rules will prohibit this reborrowing on readvanceable mortgage portions that exceed 65 per cent of your home value.
A simple example
Imagine a borrower with a $1,000,000 home value, a readvanceable mortgage with three distinct portions and a total loan-to-value of 80 per cent:
Portion No. 1: Amortizing five-year fixed: 15-per-cent loan-to-value ($150,000)
Portion No. 2: Amortizing five-year fixed: 25-per-cent loan-to-value ($250,000)
Portion No. 3: Revolving Line of Credit: 40-per-cent loan-to-value ($400,000)
Today, if you make a $100 principal payment on any portion, many lenders let you immediately reborrow that $100 from the line of credit.
Under the new guidelines, you would not be able to reborrow that $100 principal payment from portion No. 1 because your total loan-to-value is above 65 per cent – based on the property value at the time you got the mortgage.
In this example, you would only be allowed to reborrow (readvance) principal payments on portions No. 2 and No. 3.
That may lead to one unintended side effect. Borrowers who value having more LOC room might opt for a larger LOC portion and smaller amortizing portion. That is, assuming they want the ability to immediately reborrow funds when they pay down principal. We’re talking a small percentage of people here but for them, this policy change could create a negative incentive that results in higher borrowing costs.
A measured policy response
Clearly, this is far from a catastrophic curtailing of borrower credit. OSFI, to its credit, took a measured approach, likely for two reasons.
One, real estate prices in some regions are in free-fall, and heavy-handed credit tightening might have driven prices down harder. That could defeat OSFI’s purpose of fostering financial system stability.
Two, HELOCs perform extremely well. Only one in 1,000 HELOC borrowers was 90 or more days behind on their payments, according to data from the Canada Mortgage and Housing Corp. That’s a 44-per-cent lower default rate than for mortgages. And more than nine in 10 avoid the permanent interest-only payment trap, according to a new survey from RATESDOTCA.
Moreover, Canadians with HELOCs access only about 28.3 per cent of their approved HELOC credit on average, according to the latest 2021 data from Mortgage Professionals Canada. Only 6 per cent fully utilized their HELOCs.
Industry types and analysts nonetheless expected greater tightening from the regulator, such as tougher qualifying rules, which would have made passing the federal stress test harder for HELOC borrowers.
As we speak, people getting revolving HELOCs are stress-tested using a theoretical interest rate that’s up to 164 basis points below typical five-year fixed rates. That’s despite HELOCs being arguably riskier than regular mortgages in some ways – specifically with respect to their floating interest rates and ability to rack up persistent debt.
Also in its Tuesday update, OSFI explicitly capped reverse mortgages at 65-per-cent loan-to-value. This was a non-event, given reverse mortgage banks don’t lend past 59 per cent at the time of origination.
Rates this week
If you can handle the rate risk, any fixed rate under 4 per cent is a relative bargain and should perform well given the upward trajectory of mortgage rates. Unfortunately, among national lenders, True North Mortgage remains the last man standing with a 3.99-per-cent one-year fixed, and only on insured mortgages. Otherwise, the last remaining 3-per-cent-range deals to be found are at a few Manitoban credit unions and B.C.’s Community Savings – which somehow, some way, is still selling a five-year fixed at a mind-blowingly cheap 3.99 per cent.
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