It’s no secret that Canadians, taking advantage of extremely low interest rates, have taken household borrowing to unprecedented levels. In the fall of 2005, total borrowings by Canadian families, on average, exceeded 100% of net income for the first time. By the fall of 2012, despite repeated warnings by the Governor of the Bank of Canada and the federal Finance Minister that interest rates would not remain at current levels much longer, average family borrowings had risen to 152% of family net income.
Much of the borrowing in recent years has been secured by ever-increasing real estate values, and much of that borrowing has been structured as home equity lines of credit, or HELOCs. HELOCs resemble traditional mortgages in that the funds borrowed are secured by the homeowner’s equity in his or her home. Unlike traditional mortgages, however, HELOCs do not have a structured repayment (or amortization) schedule. While monthly repayments must usually be made, such payments can be as little as the amount of interest accumulated in the previous month, with no requirement to make any payments on principal. As well, once a HELOC is in place, the borrower is free to use HELOC funds for any purpose, as there is no requirement that amounts borrowed under a HELOC be used for housing or housing-related purposes. The concern expressed by federal financial officials is that it is relatively easy for borrowings through a HELOC to grow past the point where the borrower can realistically pay off the debt, or even service the debt once interest rates rise.
Several times over the past few years, the federal government has made changes which seek to moderate the extent to which Canadians can borrow against their home equity, particularly through HELOCs. The latest such change will limit borrowings under a new HELOC to 65% of the value of property which is securing that debt—in other words, the loan-to-value (“LTV”) ratio on new HELOC financing cannot exceed 65%.
The change was announced as part of new guidelines issued to Canadian financial institutions by the Superintendent of Financial Institutions. Those guidelines indicated that the Office of the Superintendent of Financial Institutions “expects federally regulated financial institutions to limit the non-amortizing HELOC component of a residential mortgage to a maximum authorized loan-to-value ratio of less than or equal to 65%….Additional mortgage credit [beyond the LTV ratio limit of 65% for HELOCs] can be extended to a borrower. However, the loan portion over the 65% LTV ratio threshold should be amortized.”
Essentially, borrowers who are taking out new home financing can still borrow up to 80% of the home’s value (remembering also that mortgage insurance through the Canada Mortgage and Housing Corporation is required where a down payment on a home is less than 25% of its value). However, at least 15% of that borrowing must be through a conventional mortgage on which an amortized repayment schedule comprising blended payments of interest and principal is required. No more than 65% of the home’s cost can be financed through a HELOC, on which the borrower is able to make interest-only payments, with no required principal repayment schedule.
There is no specific date on which federally regulated financial institutions are required to implement this change. The expectation of the Office of the Superintendent of Financial Institutions was that, where possible, such institutions would comply with the new guideline when it was released in June of this year. In any event, such compliance is required by the end of the 2012-13 fiscal year.
Whether this latest change will be sufficient to quell the seemingly bottomless appetite of Canadians for home equity borrowings remains to be seen.
The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.
