Financial Friday #111: Home Equity Loans Trouble as Prices Fall?

Home prices are stalling or falling in many markets across the country and depending on which economist or housing expert you put your faith in, prices are expected to go up, go down, or remain stable. In other words, it is anybody’s guess and what happens going forward may also vary drastically depending on your regional or local housing market. For example, do smaller price increases in Edmonton and Calgary over the last year mean they are more insulated against prices drops than other Canadian markets?

Either way, existing homeowners in many areas may need to deal with a significant drop in their equity, and the effect of that could range from "ho-hum" to lurching for the panic button.

The Office of the Superintendent of Financial Institutions (creators of the mortgage stress test among other duties) data showed a record surge in home equity line of credit (HELOC) borrowing during February, reversing a gradual 13-month decline in just 28 days. While the cause for this spending splurge is not so transparent, what is very clear is that a lot of people depend on their home equity, whether it’s for a Hawaiian holiday or simply to buy groceries when they come up a little short before their next payday.

Most HELOCS are demand loans and although your financial institution could exercise this right or put a cap on your current balance, they rarely do so — unless you start missing payments! Even if you are bumping up to you current HELOC limit but still making the payments, they will most likely leave you alone. However, if you counting on borrowing (or borrowing more) against your equity to cover your monthly spend or a shiny new Winnebago, you might have to re-evaluate those plans. Lenders will certainly be looking more closely at income and ability to pay when it comes to dishing out home equity loans if real estate prices start to tumble.

For any retirees who may have been eyeing a reverse mortgage, any drop in equity will lower the total amount you can draw as it is capped at 55% of value. Reverse mortgages also become less attractive compared to selling outright when "expected" future equity gains are removed from the equation.

Another topic that is now hitting the news is buyer’s remorse — the previously unthinkable situation where recent home buyers quickly become underwater (owe more than what their home is worth) as prices start to fall. No one likes paying too much for anything, but most of us will get through buying a few tomatoes or even a new computer only to see the price fall a week later. Forking out way too much for a house is another story and it can easily cost you tens of thousands if you had to sell or downsize.

If you are negative on your equity but you needed a place to live and are in it for the long term, chalk it up to poor timing (unfortunately, you may have to say the same about any stocks you purchased over the last year!). Chances are good the value of your home (and those stocks!) will recover if history is any indication.

The advent of "re-advanceable mortgages" tied to HELOCs that allow one to borrow a large percentage of their equity almost as fast as they generate it is causing issues and confusing many Canadians. As home prices slide, it becomes more important than ever to understand not only the the legal conditions and obligations of your mortgage, but also the implications and possible consequences of spending your equity.

Resources:

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