About two million Canadian homeowners have home equity lines of credit (HELOCs) — and many of them are likely to see their borrowing costs go up in the next few months.
HELOCs are credit lines backed by a borrower’s equity in her or his home. They work a bit like a mortgage and a bit like a credit card.
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HELOCs allow you to borrow a certain amount, based on the amount of equity you have in your home. Lenders these days tend to treat HELOCs like a mortgage add-on.
If you buy your house with a down payment of 20 per cent or more, your bank will likely offer you a so-called readvanceable mortgage, which bundles a mortgage and a HELOC. As you pay down the principal, you free up credit in your HELOC. However, you don’t need to have mortgage to have a HELOC, as long as you are a homeowner. Over 1.5 million Canadians have a mortgage and a HELOC, while some 490,000 have a HELOC and no mortgage, according to Mortgage Professionals Canada.
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But HELOCs work like credit cards in other important respects. They give you access to a certain amount of credit but, unlike a loan, you don’t have to actually borrow the money until you want or need to. HELOCs don’t have an amortization, or a set schedule for you to pay off what you owe. And most of them allow you to make interest-only payments.
There are two other similarities between most HELOCs and most credit cards: They both have variable interest rates and they allow lenders to hike those rates at their discretion.
That’s where the risk of rising rates comes in.
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Two reasons why HELOC rates will likely keep climbing
The interest on HELOCs is the lender’s prime rate plus a premium. HELOC rates rise when the prime rate goes up, when lenders hike the premium, or both.
The prime rate almost always moves in tandem with the Bank of Canada’s key interest rate. When the BoC hikes rates, the big banks raise their prime rates (and usually all of them have the same prime rate). So far, prime rates have climbed by 0.75 of a percentage point since July, as the BoC upped its key rate to 1.25 per cent from 0.5 per cent.
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That might look like a tiny increase, but things look different when you actually do the math. A rate increase of 0.75 of a percentage point translates into an increase of 23 per cent on a HELOC with an interest rate of 3.2 per cent, which was common among the big banks before the BoC’s July increase.
And since the BoC says it isn’t done raising rates, rates on existing HELOC likely have further to go.
CIBC and TD sees the BOC’s policy rate rising to 1.5 per cent by the end of this year and to 2 per cent by the end of 2019. RBC expects rates to be at 2 per cent by the end of 2018 and 2.25 by December 2019.
And BMO and Scotiabank are forecasting the rate at 1.75 per cent by the end of 2018 and 2.5 per cent by the end of next year.
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On top of the increases that come with any movements in the prime rate, some borrowers may see their premium on the prime rate adjusted upward.
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TD Bank, for example, recently told a few of its customers that it will be raising the rate on their HELOCs by between 0.2 and 0.5 of a percentage point starting June 3, according to a recent report in the Globe and Mail.
Rob McLister, mortgage planner at intelliMortgage.com and founder of rates-comparison site RateSpy.com, told Global News he hasn’t detected a trend of lenders hiking rates on specific borrowers.
James Laird, president of Toronto-based CanWise Financial, also hasn’t heard of lenders increasing their HELOC premium on select credit lines.
For new lines of credit, right now Canadians can generally access interest rates at prime (3.45 per cent for the big banks) plus 0.5 per cent, though some lenders have promotions offering HELOCs at the prime rate, according to McLister.
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What you can do ahead of the next interest rate hike
If you’re worried about being able to afford your HELOC payments as interest rates rise, you should consider converting your credit line into a fixed-rate mortgage, Laird said.
Indeed, converting a HELOC into a mortgage is good practice for anyone with a large balance on their credit line, he added.
For example, the flexibility of HELOCs is great for financing a renovation, when you might need to pay different contractors on a rolling basis and don’t know with certainty how much the project will end up costing you overall.
But once the paint is dry on the walls of your renovated home, you should turn your HELOC into a mortgage. It makes little sense to pay today’s HELOC rate of 3.95 per cent on, say, $350,000 when you could be paying a lower fixed rate with a mortgage.
Even converting to a variable-rate mortgage might make sense, as variable mortgage have rates that are considerably lower than HELOC rates, Laird said.
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What you can do to avoid a hike on your individual HELOC
“Lenders do hike HELOC rates to mitigate risk and/or improve margins,” McLister told Global News via email. “They’ve also been known to cap credit limits if risk warrants.”
The key to avoid that, he said, is “staying below the radar with your HELOC lender.”
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Make every minimum payment on time and avoid making interest-only payments months after months, McLister said.
If you go years without putting money toward the principal, “you’ve got to think the bank is going to notice.”