Brian Matthey

Got aHELOC? Your Mortgage Options Are About to Shrink ByThe SpyonNovember 6, 2018 For more thana year weve speculated that new rules will be adopted, making it tougher to qualify for aHELOC. How could they not? TheBank of Canada,OSFI, CMHC and FCAC have all been warning about HELOC risk for months. And when multiple government agencies target a financial product, change is acomin. And now its here. Banks are tightening rulessignificantlyfor those with a HELOC who are applying for a new mortgage (and not closing their existing HELOC). But this time, its not a well-publicized government rule. Its happening behind the scenes. How people get approved today Lets assume youre applying for a new mortgage on a second home, cottage or rental property. Also assumeyou have a HELOC with a $200,000 limit. Today, most lenders will make you prove you can afford the payment on themoney you owein that HELOC. If your HELOC has a zero balance, its of little consequence to your mortgage application. If you do owe money in your HELOC, most lenders calculate your assumed payment based on: the HELOC balance owing the lenders posted fixed rate (commonly the 5-yearposted rate, or 5.34% today), and a 25-yearamortization. Heres whats changing Take the exact same scenario as above, but now assume the lender makes you prove you can afford a payment based on your HELOC creditlimit. Even though you might have a zero balance, the bank assumes you might use all of your available credit. It therefore adds a hypothetical $1,334 a month payment to the debts on your mortgage application. As this chart depicts, the impact is momentous: This policy change would (will) push tens of thousands of borrowers over the maximum allowable debt-ratio limit, preventing them from getting the mortgage they seek (unless they make adjustments; see below). The above example is based on the $200,000 HELOC limit, a 25-year amortization and a stricter 6.45%qualifying ratefor illustration purposes, given higher rates could eventually apply. Today, the most common rate lenders use to qualifyexistingHELOCs is 5.34%, much higher than thebest HELOC rates. Using 5.34%, lenders would apply a $1,202 theoretical payment to the borrowers mortgage application. That results in a still-offside 51%TDSratio. Heres how the chart looks with that assumption (still a huge impact on borrowers): Why it matters Roughly 3.1 million Canadians have HELOCs, according to CMHC. The number of people impacted will be a meaningful minority of that number. Given the median homeowner household makes about$7,400a month, adding a $1,334-a-month paymentalmost 20% of gross incometo their debts (for mortgage qualification purposes) is big potatoes! Take a typical borrower with an average total debt service (TDS) ratio of 35%, for example. If that person wishes to retain his or her $200,000 HELOC (whether they use it or not), suddenly their TDS ratio soars to over 50%. The result: they no longer qualify for additional financing. (Note: 44% is the maximum TDS limit for prime HELOCs, but 40% or 42% is more common.) This rule update is market-moving. And intuitively, its purpose sort of makes sense. But dont be fooled, saysbroker Shawn Stillman ofSigma Mortgage. Its just chipping away further at borrowers options. Whos doing it So far, three of the six largest banks have moved to this debt-ratio calculation method. Canadas undisputed leader in HELOCs (TD Canada Trust) just made the change November 5. TD explained its logic in this email to RateSpy: TheDebt Service Ratiochange was made to ensure prudentunderwritingguidelines, and reflects concerns around consumers abilities to manage debt particularly in a fluctuating rate environment. Before this change, a borrowers capacity to service their entire authorized limit was not assessed, even though the borrower had access to those funds. This change helps ensure our customers make informed financial decisions by assessing their affordability on the available lines of credit they currently hold in addition to any credit they apply for. The change aligns with our existing prudent underwriting guidelines, with the impact being limited to a small number of customers that have an existinghome equityline of credit and are applying for additional financing. RBC, Canadas second-biggest HELOC lender, is using a similar method. Earlier today, it told us: RBC reviews every mortgage based on a number of factors, including a clients credit worthiness and history, and their ability to repay. When evaluating an applicants capacity to repay we need to understand their total financial picture. We are unable to see if a HELOC from another financial institution is secured or unsecured, so we assess the client on the assumption that they could draw on the available credit at any time rather than assuming the balance at the time of application will remain unchanged Whos behind all this This came from somebody in the government, Stillman says. Banks never would have had a eureka moment and said, We need to do this from a risk point of view. Its not justified withdelinquencies of 25basis points. And heres some more relevant stats: Homeowners with a HELOC (and no mortgage) have81%equityon average, according to data from Mortgage Professionals Canada. The number of standalone HELOC holders who borrow more than 50% of their equity is just 7%. Broker Ron Butler ofButler Mortgageagrees. Lets face it, TD is the biggest HELOC provider in Canada. Chances are, OSFI is trying to put a lid on [HELOC growth] because, factually, rates are guaranteed to rise 50 bps at least, 100 bps at worst, in 12 months. For a government who has a hard time not interfering in anything, its tough to leave that one alone. Indeed, this issue has been on policy-makers radars for a while. A senior banker we spoke with yesterday, who didnt want to be named for obvious reasons, told us that OSFI inspired this policy. We asked OSFI to confirm that and the banking regulator told us: When underwriting a new HELOC application, as per B-20 principles, OSFI expects federally regulated financial institutions (FRFIs) to ensure the borrower has the ability to expect full repayment over time, which means theGross Debt ServiceRatio (GDSR) for a HELOC application should be calculated based on the HELOC limit requested. When underwriting any loan application where the borrower has an existing HELOC in place, FRFIs may use either the limit, or outstanding balance of the HELOC, to estimate an assumedpayment in calculating the Total Debt Service Ratio (TDSR) for this loan application.It is at their discretion, however OSFI expects that, given the revolving nature of a HELOC facility, FRFIs will take a longerterm(and conservative) view of the borrowers debt servicing requirements. Borrower workarounds If: you want a mortgage you have a HELOC that you want to keep your prospective lender stress tests you based on your HELOC limit you have higher-than-average debt ratios then here are some of your options: Find another lender As mentioned, only a handful of lenders use this policy now, but as Stillman notes, This industry is all monkey see, monkey do. Given OSFIs priorities, we expect most big banks, if not all, to apply it by year-end, or next year at the latest. Many non-federally regulated lenders who get their funding from banks should also follow suit. Expect lenders who dont apply this debt-ratio policy to charge higher rates for this service (just as credit unions do for borrowers who dont pass the federal stress test). Lower your HELOC limit Banks that stress test you on your HELOC limit will try hard to retain your new mortgage business. Two ways theyll do that is by recommending you: convert your HELOC debt to an amortizing fixed or variable-rate mortgage. lower your HELOC limit(s) so you qualify for new financing. Close your HELOC A minority of affected borrowers may choose to close their HELOCs altogether. Others may trade them in for an unsecured credit line (which are typically qualified based on 3% of the balance, at least for now). Get a co-borrower. Who wins The economy, say policy-makers They argue that its economically beneficial because less risky HELOC borrowing (and accounting for what borrowers might borrow) makes the economy more stable. Thats apparently notwithstanding the fact that HELOCarrearsarelessthan mortgage arrears and near an all-time low. Nor does it account for the economic and jobs benefit of greater HELOC liquidity (which has never been OSFIs guiding consideration). Lenders that can convince existing borrowers to lock in HELOC debt to fixed rates (assuming those fixed rates are more profitable for the lender) and stay with them. Mortgage brokersbecause they have lender solutions banks dontand they know which lendersarentapplying the new policy. Who loses Consumers HELOCs have countless prudent uses.Restricting them further reduces economic opportunities for investors and cuts fallback liquidity for Canadians who rely on HELOCs to weather economic shocks. Mortgage brokers (yes, they win and lose) If you say to a borrower, You dont qualify for a mortgage because of your HELOC, the first thing theyll do is go to their bank and ask how to fix it, says Stillman. The bank will tell the borrower theyll work with them to get them approvedifthey get their mortgage through the bank. And a good chunk of these borrowers will then stay with their bank. Looking to the Future The higher rates go, the harder itll become to qualify for a HELOC and/or a mortgage if you already have a HELOC. In a rising rate environment, at what point doesitnotmake sense to add two points on the stress test anymore? Stillman asks.If we get three more hikes, as the markets predict, the qualifying (stress test) rate on HELOCs could exceed 7%. Coupled with stricter debt-service policies, HELOC growth would collapse in this scenario. (Regulators end-game?) Its going to hurt the upper end of the market, people with higher priced properties that have big HELOCs, Stillman predicts. This will further slow real estate given many of those people rely on HELOCs to buy rental properties, cottages or second homes. With every new lending rule comes higher costs for prudent consumersand increased risk for borrowers who gravitate to more costly (higher risk) lenders. This one will be no different. Rightly or wrongly, theres an obsession in Ottawa with borrower risk. It makes you wonder how far theyll go to stamp it all out. Next thing you know, lenders will be asked to assign a hypothetical payment to peoples credit cardlimits. (We say that only half jokingly.)