HELOC Rule Changes: More Significant Than You Think

HELOC RulesWere TD’s bombshell new HELOC rules inspired by the government’s master plan?

You be the judge.

Our take: HELOC rule changes are about more than just stopping speculators from funding secondary properties. And TD’s move is just a precursor.

Regulators won’t come right out and say it, but people we talk to are certain that OSFI and the Department of Finance are working to persuade banks to stress test all HELOCs (not just new ones) based on the borrower’s credit limit, not just the balance.

Consider all the different ways that HELOCs are used in this country.

Consider all the different parties that will now be impacted if every bank adopts TD‘s and RBC‘s policies:

For example:

  • Renewers
    • Got a big HELOC and want to switch lenders for a better rate? Not so fast.
    • If you have average debt ratios, there’s a decent chance you’ll have to cut your HELOC credit limit in order to qualify for the new mortgage.
    • That could very well require an entire refinance (and its extra costs).
  • Banks
    • Expect another increase in customer retention at the Big 6.
    • Many folks will simply have no desire to go through the hassle of restructuring their HELOCs and applying elsewhere.
    • Will the retention benefits offset the profit machine that HELOCs have become (given 40% of people don’t make regular principal payments)? That is the question.
    • Bank regulators, as well as Department of Finance, have concerns about all the untapped HELOC room out there. It’s no coincidence that Ottawa has been making big, unused HELOCs more expensive for banks to carry on their books by way of stricter capital requirements.
    • That’s on top of the “liquidity premium” banks must absorb for unused HELOC room. A capital markets expert we spoke with today estimates that cost at up to $70 per $100,000 of unused HELOC space, plus opportunity costs.
    • For customers with little other business at a bank, higher capital costs are making banks less enamoured with customers who have big, persistently untapped credit lines. That, in turn, could make banks more prone (in some cases) to lower borrowers’ credit limits and/or hike those borrowers’ HELOC rates.
  • HELOC RiskHigher-Risk Consumers
    • OSFI’s Guideline B-20 requires banks to monitor credit risk and loan-to-value regularly. Banks will increasingly become wary of borrowers with big HELOCs. Again, this movement to discourage unutilized HELOCs is no accident.
    • Going forward, banks may increasingly take action when they see borrowers with a declining credit score who rarely make principal payments and are steadily racking up their credit line. Bank measures may include hiking the borrower’s rate (not a perfect solution given this also heightens default risk with over-leveraged borrowers), lower the borrower’s limit, force that borrower to amortize their HELOC balance, or freeze the HELOC altogether (a drastic but rare case for a borrower who’s been paying as agreed). If home values are declining, especially if they’re declining rapidly, the odds of banks taking such actions increases.
  • Private mortgage investors
    • These folks regularly use their HELOCs to fund private mortgages.
    • Policy-makers are concerned about growing risk in the private market.
    • Some economists are even advocating regulating private lenders. (A short-sighted move that would ultimately: [A] push more people into the arms of high-cost credit card companies, and [B] hike default and insolvency rates.)
    • Barring that, what better way to slow private lending than to chip away at its funding sources (like big, fat HELOCs)?
  • Mortgage Investment Corporations
    • How many thousands of HELOC holders borrow at 4.45% to make 8-9% with a MIC?
    • Again, the liquidity effect here could be (will be) significant.
  • HELOC rule changeThe Bank of Big Daddy (and/or Mamma)
    • From 2015 to 2018, almost $4 out of every $10 of first-time buyers’ down payment funds came from a “gift from parents or other family members,” according to the ever-insightful Will Dunning at Mortgage Professionals Canada.
    • If parents need to cut back on their HELOCs to qualify for their own financing, how will this impact newbie homebuyers?
    • And if empty-nesters are co-signing for their kid’s new home, and those parents have a HELOC that’s now qualified at the limit instead of the balance, in some cases the parents will no longer qualify (and hence, their kids will no longer qualify).
  • Investment Advisors
    • 25% of HELOC borrowing is used to invest, much of that in stocks and other non-real estate investments.
    • Untold thousands of savvy homeowners get big HELOCs so they can borrow low-cost funds and earn a “spread” on their other investments. This trend towards smaller HELOCs could work against advisors who employ this strategy.
  • Self-employed Borrowers
    • More than 3 million Canadians are self-employed.
    • Many use HELOCs to fund their business.
    • And many of those report little income (because they write down their income, in most cases legally).
    • If these borrowers:
      • Show lower reportable incomes
      • Have a HELOC separate from their mortgage
      • Want to refinance that mortgage……They will eventually be tested on their HELOC limit, and scores will no longer qualify for a replacement mortgage. Where is that client going to go? The answer is they’ll be relegated to renewing with their existing lender.

*******

All told, this is “worse than the stress test,” opined one banker I spoke with today. We differ in opinion on that but suffice it to say, TD’s HELOC change—if it foreshadows other banks following suit—will be far more impactful than many now realize.

Of course, government regulators are unfortunately 10 years late to the party. Tightening HELOCs in 2018 will have a more negative (and many argue, necessary) impact on the economy than it would have had in 2008. But as Arthur Conan Doyle once said, “It is easy to be wise after the event.”

introspectionIndustry Introspection

Any banker or broker contemplating recommending a HELOC should ask themselves one question: Should I really be selling a big credit line to this borrower?

If there’s a chance the borrower will want to refinance later and keep their HELOC intact, the answer is likely “no.”

Sure, a modest-sized HELOC may be very appropriate as a source of liquidity for financially capable borrowers. In fact, you can get some HELOCs with a starting limit of just $1. They automatically grow as you make principal payments on your mortgage. For a qualified borrower, having a HELOC as an emergency resource or alternative to high-interest credit can make sense.

But make no mistake. The days of selling $200,000 HELOCs because you can, or because you get paid a bigger commission from the lender, are coming to a close.



4 Comments

  • Yolo says:

    A very thorough and accurate analysis. As mentioned previously, the credit cycle is firmly in contraction mode. The expansion phase ended in 2016 and the banks have been working together with OFSI to come up with regulations to restrict excessive credit growth. Originally the plan was to push borrowers to insured products (with a stress test) but when borrowers found workarounds and moved to the uninsured market the stress test became universal. The banks wanted a reason to restrict uninsured lending and OFSI has given them just that (and then some). Note how insured products are still available with lower rates, a scenario that didn’t exist 10 years ago. That’s not to say I agree with any of these policies but that’s what they are. The banks welcomed these regulatory changes and they’re not concerned that it gives consumers fewer options.

  • Blackbloggs says:

    Does anyone know if this will affect people who use their HELOCs for the Smith Manoeuvre?

  • The Spy says:

    @Yolo: Appreciate your note.

    @Blackbloggs, Folks with greater than average debt ratios who get big HELOCs for the Smith Manoeuvre and have lots of excess borrowing room, may eventually find that their mortgage refinance options aren’t what they used to be. For leveraged investors who have already borrowed near their credit line limit, this change has relatively little impact.

  • Banker says:

    Banks constantly monitor their HELOC exposure. Any impairment in their HELOC portfolios would be spotted early and taken seriously, if for no other reasons than the capital hit, investor reaction and regulatory attention it would draw.

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