Arranging home equity loans and lines of credit can be a big boost to a mortgage broker's business, particularly in these times of tightened credit, low housing inventory and increased job loss. As the spring and summer housing market cools, Paul Bath of Centum Hewmac Mortgage Centre in Newmarket, Ont., says these products have become a major focus of his business.
"Right now we're doing more refinances and home equity loans and lines of credit than we are purchases," he says, citing debt consolidation and home renovation as the two most popular reasons his clients look to the equity in their homes for extra cash.
Other reasons people borrow against their homes can include paying for a wedding, or using the extra money for investments, businesses or tax-deduction purposes. Recent research by CIBC World Markets also showed Canadians are relying more and more on their homes as retirement safety nets. Economist Benjamin Tal said that as of the second quarter of 2009, 38.5 per cent of Canadians' wealth is tied up in home ownership, up from about 16.3 per cent two decades ago.
Regardless of reasons, setting up a client with a home equity loan or HELOC means navigating through a range of product options and borrower criteria, which varies from lender to lender. Like a first mortgage, if a client doesn't qualify for a home equity loan at an institutional lender, there is also the task of finding a private or B lender that will get the deal done.
Types of home equity loans
There are two main types of home equity loans - a fixed-term HEL, which is a lump sum payment and can also be referred to as a second mortgage; and a home equity line of credit (HELOC), which is a revolving loan generally tied to the prime interest rate (lenders can also raise rates on these products).
The common thread between these types of loans is that they both become debt secured against the borrower's home (as opposed to unsecured debt, such as a credit card).They also, in general, only go up to 80 per cent loan-to-value at the institutional lending level, with private lenders sometimes allowing borrowers to push that number higher.
"There is some confusion about how companies market home equity loans," says Rajan Kaushal, president of the GTA-based private mortgage lender The Money Source. "But as soon as a loan or line of credit becomes secured on a property, it becomes a second mortgage."
Janice Rickard, mortgage broker and manager of corporate underwriting at RMAI Financial, often recommends a HELOC over a home equity loan because it is readvanceable, it has low upfront costs and, in some cases, it can be segregated (i.e. a husband and wife can have their own separate accounts from one line of credit). She adds that having a HELOC can provide protection against title fraud because it creates a charge on an owner's title even after the loan is paid off.
But Rickard also points out that HELOCs are usually reserved for 'A' clients who have solid credit and stated income. If someone doesn't qualify, she will check and see if they can get a co-signer - which is still workable on certain home equity loan products - before seeking out alternative lenders.
Paul Bath also likes HELOCs over HELs because he says they are usually lower cost in the long run. But he points out there are instances when a lump sum with fixed payments is a better fit - and, in some cases, banks will pick up the tab for legal and appraisal costs for a home equity loan whereas they tend to pass these onto the client for a HELOC.
"If a client is doing a major renovation like a kitchen or basement and the contractor is going to have it done in two to three months, then I would do the home equity loan," says Bath. "The beauty of them is that the client has permanent payments, so they are always going to be reducing the mortgage in the long run."
He adds the most common mistake he sees when people get a HELOC is that they think of it like a regular line of credit and not a mortgage against their house.
"A lot of times they don't understand that even when they're told - we've run across that many times," Bath says.
Private versus institutional
Like HELOCs, home equity loans granted by institutional lenders are reserved for clients with strong credit scores and stated incomes. In addition, they cannot be used to pay off tax arrears, judgments, collections or missed first mortgage payments.
When a client is looking for a second mortgage or home equity financing but doesn't have the requirements to qualify at a financial institution (or with a mortgage insurer), the next option is finding a private or 'B' lender that has more lenient underwriting standards and doesn't require mortgage insurance.
At the private home equity lender Capital Direct - which has offices across Canada - loans are still granted based on the basis of beacon score, but there is more flexibility and the appraisal of the property significantly contributes to how much someone qualifies for (homes in urban areas are easier to obtain loans from than those in rural places).
"Basically, the loans are for people who can't verify their income - which is the case when they come to us about 90 per cent of the time - or they've gotten themselves into some trouble with their credit score," says Moe Haymour, a business development manager at Capital Direct, adding the score is still important due to the risk involved. "We want to make sure that even though it's an equity deal the client is still comfortable paying those debts."
Haymour adds that even clients with very poor credit scores have the potential to qualify, although they might need to give six to 12 months of payments to the lender upfront for security.
For 'A' clients who are using home equity loans for debt consolidation after they've lost a job or suffered another financial blow, Bath says they can still qualify with an institutional lender if they act quickly.
"A lot of lenders rely on the beacon score, so most clients, if they are ahead of the game, do debt consolidation right when they start getting into trouble and we can place them with any lender as long as the formulas like the TDS and GDS work," says Bath. "But if clients wait too long and the beacon score drops down to the low 600s, then we have to send them to B or private lenders."
Interest rates are, of course, higher at private lenders - they start at 11.99 per cent at The Money Source and 7.75 per cent at Capital Direct. Then there are additional fees, which start at two per cent of the loan amount. Terms are also shorter at a private lender - one to two years - so clients can look at placing the loan somewhere else when their situation has improved or when they can pay off the loan through a refinance or sale.
Client cautions
For most borrowers, it makes sense to take out a home equity loan or line of credit with the same lender they have their first mortgage with. But if that can't be arranged, a private lender can go behind another lender for a second mortgage, says Kaushal. He adds there are only a few lenders and a few cases where he has seen the first lender put a restriction on a borrower to take out a second mortgage with another company.
If the customer opts for a straight HELOC or a re-advanceable mortgage with a HELOC feature, the money goes straight into a chequing account (no lawyer required). But even with a product as simple as a HELOC from an institutional lender, Rickard says she still precautions her clients.
"With HELOCs, the No. 1 thing is to make sure the client is very aware that there isn't a protection against rising interest rates because the line of credit is tied to prime," says Rickard. "There is also a concern that the client will tend to look at the HELOC as a regular line of credit and not a mortgage and therefore there isn't as much incentive to pay it down." Bath also reiterates to clients that they are taking on more debt so they have to be careful, especially with the option of interest-only payments.
"With the line of credit, I really encourage clients not to just make the minimum payment but to treat it like a mortgage and pay it down so you build up some equity in the house because that's the whole goal," he says. "I also remind clients that they've incurred more debt that is going to take up to 20 years to pay, so they've got to watch out for any new debt down the road and watch out for getting too comfortable and borrowing more money."
CAAMP's spring mortgage survey showed that 15 per cent of Canadians cashed out equity in their homes over the past 12 months, with 57 per cent of that number using all or part of the funds for debt repayment and consolidation. With increasing unemployment, many clients are likely to continue inquiring about home equity products, making it important for brokers to stay educated on product offerings and have a plan B if deals with institutional lenders don't go through.
"Second mortgages are a very niche product," says Kaushal. "We find that a lot of our strong brokers are very knowledgeable about it because it's great for them to be able to provide a product that isn't as readily available in a bank."