Too much

@hugo_the_newfie, Australia

Well, this is no surprise. If you have a secured line of credit arranged at the bank – whether it’s drawn or not – the feds just put you in the crosshairs. We hinted days ago it was coming. Now it’s here. The consequences could be far-reaching at a time when real estate’s wobbly from both the stress test and (especially) swelling interest rates.

The move comes on the heels of the bank cop (OSFI) requiring everyone (including those renewing a mortgage and switching lenders) to qualify for a loan at an elevated rate. The stress test dictates it must be the bank offer + 2%, or the benchmark of 5.3% – whichever’s higher. Before long that will be over 6%.

Now the feds have raised the alarm about HELOCs. No wonder. These borrowings, secured by real estate equity, have turned houses into ATMs. People have swarmed the banks to get them, and currently we owe $235 billion, up 35% in the last eight years. Home equity LOCs are sweet because they come at a low rate (usually prime plus a half), are immensely flexible since you can borrow or pay off as much or as little as you want, when you want, and they’re cheap to carry. About a third of borrowers, for example, never pay them back – they just keep making interest payments on the outstanding amount.

Canadians use HELOCs for three main reasons: (a) to renovate real estate, (b) buy more real estate, like a cottage or a rental unit, and (c) hand their spawn money for real estate.  Given the fact we’re in a property price bubble with household debt at historic levels and interest rates steadily inflating, lending people funds to buy more real estate based on the inflated, imperiled real estate they already own is a seriously bad idea. Ottawa just got it.

But, like I said, too late. Those hundreds of billions have been loaned. The cost of money will rise another four or five times (says the central bank). So if borrowers can’t pay down the principal now, what’ll they do in a year? How much risk have the banks walked into? Isn’t this exactly what the American lenders did – pretend real estate values would forever rise, and keep lending against them?

Okay, so here’s a change. This may sound modest at first blush. It’s not.

Effective immediately bankers will assume you have borrowed all of your LOC, even if you’ve borrowed nothing. The monthly payment required to service that full amount will be used to determine your debt-ratio limit and, in a majority of cases, push it beyond the red line. That would prevent borrowing more money on the line or expanding/refinancing or possibly renewing an existing mortgage. You could not switch lenders to get a lower rate without facing the stress test – which you’d fail.

This will cause a lot of folks to slash their HELOC limits, eliminating a financial safety net for the prudent. It will make people think twice about using those lines to buy secondary properties or hand over borrowed down payments to their kids. It could make investors wary about dipping into their equity to diversify into financial portfolios.

This also showcases how the feds are freaking over our steaming mountain of family debt and the impact rising rates will have. Three million households have HELOCs. It’s been the fastest-growing form of borrowing. Most of the cash is being plowed right back into the same asset class – residential real estate. It’s as if we learned absolutely nothing from the American housing collapse which created a global financial crisis.

Like the stress test, this move’s designed to tap the brakes, forcing banks to be way more badass than in the past. HELOC growth could shudder to a halt. The biggest impact might well be on the Bank of Mom, funded by home equity. And do not underestimate the effect those coming rate increases will have. Within four years all existing mortgages will have renewed at higher rates, while HELOC costs balloon immediately with every Bank of Canada adventure.

And, yes, there’s more to come.