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Rising rate environment bad news for HELOC borrowers

by Neil Sharma Jun 2018 MBN

We’re officially in a rising interest rate environment, and that could spell trouble for some homeowners who have taken out home equity lines of credit.

Principal balances aren’t usually required to be repaid on fixed schedules and the Bank of Canada has said roughly 40% of HELOC borrowers don’t pay down the principal.

According to Michael Garrity, CEO of Financeit, Canada has entered a rising rate environment for the first time in about two decades and warns a lot of people with HELOCs don’t remember that they’re callable.

“A lot of people who have HELOCs don’t remember that they’re interest-only variable interest loans that can be recalled at any period in time where the bank feels they have too much exposure to debt,” he said. “They’re great borrowing instruments for short duration purchases, but they’re not great budgeting tools for homeowners thinking about major purchases and want certainty on how much they pay over a five-year period.”

Another danger in a rising rate environment is monthly repayment instalments could conceivably double in a short amount of time.

“If you think about a rising rate environment, you can literally have a doubling of the amount you have to pay every month with the HELOC and there’s nothing you can do about it,” said Garrity. “If rates continue to rise over a five-year period, what you’re paying today monthly could literally double, and that’s just to service the interest, not principal.”

Financeit offers borrowers cloud-based financing—essentially meaning it isn’t a paper-based application—for home improvement jobs with fixed instalment payments. Garrity estimates only 20% of Canadians could afford an emergency purchase like a new furnace.

“Our view is that instalment loans with a fixed rate and fixed duration where you, as a homeowner, know the amount you’re going to pay every month and know that it’s not going to change,” he said. “That type of lending hasn’t been very popular for the last 20 years, but as rates are going up we think it’s going to be an increasingly popular type of borrowing. It’s about payment certainty, interest rate certainty, and budget planning.”

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