HELOC holders could find budgets squeezed by rising interest rates

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Rising interest costs are already creating problems for some Calgary homeowners, who find their budgets increasingly overwhelmed by home equity line of credit debt, says a local mortgage broker.

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“This year we’ve seen people struggling with their debt payments to the point of selling their homes to buy something less expensive to consolidate debt into one payment or even eliminate it,” says Matt Leggett, senior vice president and mortgage broker. at Ratehub.ca in Calgary.

“We don’t normally see that, but it’s happened a lot now because people are having a hard time keeping up with payments on their home equity lines of credit.”

His comments come in light of a new study showing that many Canadian homeowners with a home equity line of credit, or HELOC for short, currently have an outstanding balance.

The survey by online mortgage marketplace RatesDotCA found that 58 percent of homeowners with a HELOC carry a balance, and about eight percent make interest-only payments.

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As the Bank of Canada raised its overnight interest rate to control inflation, interest rates on these variable products have risen significantly in recent months. Rates are now jumping again after the Bank of Canada’s latest announcement on July 13 raising its overnight another 100 basis points.

The RatesDotCA study also notes that Canada’s HELOC debt is not insignificant, reaching $167 billion in March, according to data from Statistics Canada.

Among the reasons for using their HELOC, the survey found that more than three in 10 Canadians used it for home renovations.
Similarly, 30 percent used their home equity to consolidate higher-interest debt at a lower rate, while 13 percent paid for a vacation with their HELOC.

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RatesDotCA mortgage expert Sung Lee in Toronto notes that rising interest rates on HELOCs have a greater impact on family budgets compared to adjustable-rate mortgages because of how interest costs are calculated.

“Depending on your amortization, the interest rate increases with an adjustable rate mortgage are not that significant because the calculation is based on amortization,” he says, adding that the payment is a combination of interest and principal. In most cases, borrowers see their amortization increase but not their monthly payments.

However, interest costs on a HELOC are calculated on the full amount owed, “so you’ll often see bigger jumps in monthly payments.”

He adds that using a HELOC for home improvements in the low interest rate environment for the past several years made sense as long as homeowners had a payment plan.

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The study found evidence that many, 55 percent, were paying off HELOC debt.

Additionally, new OSFI (Office of the Superintendent of Financial Institutions) rules beginning in late 2023 will limit the maximum that home equity borrowers can access to 65% instead of the 80% currently allowed.

Homeowners with preexisting debt above that threshold will have to make principal payments until the amount falls below 65 percent.

Leggett says people with HELOC debt are better off paying it off as quickly as possible given rising interest costs. In addition, HELOC debt can negatively affect your ability to move because these costs increase your total debt service ratio, which cannot exceed 44 percent.

“Many other things have also changed, hurting borrowers, including the stress test (OSFI),” he adds.

A few months ago, most borrowers had to qualify at 5.25 percent, the Bank of Canada’s fixed benchmark rate. Now most must qualify for the mortgage interest offered plus two percentage points.

“That means qualifying close to six percent,” says Leggett. “So some now can’t qualify based on all of these factors.”