A HELOC (Home Equity Line of Credit) is a loan that is secured by real estate and is a cost effective and flexible way to access equity from real estate assets. Many Canadian homeowners have a HELOC registered against their properties giving them access to relatively cheap money that could be used for investments, renovations, emergency funds, mid life crises sports cars, or even the down payment on an investment property!
If you are one of these homeowners with an existing HELOC and are looking to expand your real estate portfolio to buy a rental, vacation home, or perhaps refinance a rental property to pull equity that existing HELOC could have a massive impact on your ability to borrow. This is because different lenders consider existing HELOC loans very differently in a mortgage application. Some will debt service the LIMIT of that credit line, while others will only debt service the BALANCE.
(Side note: the term “debt service” refers to the lender’s requirement to include any monthly debt obligations a client may have into the mortgage application. This could be car loans, student loans, credit card debt, or HELOC payments. More income servicing existing debt every month means less money to service new mortgage debt, resulting in a reduced mortgage approval amount)
Lets say Fred has a house worth $1M which is his primary residence, he has a mortgage balance of $300K, and a HELOC Limit of $300K which is currently sitting empty with a $0 balance. Fred approaches his preferred bank, Bank A as he wants to purchase a rental property. Bank A sees that Fred has a $300K Limit on his HELOC, their policy is to treat that HELOC as if it were MAXED out in his new mortgage application, even though he doesn’t owe a dime on it. This means Bank A will calculate the payments required to service this additional $300,000 worth of debt, this will increase Fred’s overall debt service ratios, meaning he will qualify for much less for his new mortgage.
Fred decides to call his favorite mortgage broker for a second opinion, the broker looks at Fred’s current portfolio and recommends Bank B instead. Bank B debt services the BALANCE on existing HELOCS, and not the LIMIT. This means that Bank B sees the $300,000 HELOC, sees that there is currently $0 owing on it and as a result they don’t include any payment obligation for this HELOC in his new mortgage application. Suddenly Fred is approved for substantially more mortgage, gets the approval he needs, buys his rental property and gets tenants that always pay their rent early! A happy ending indeed.
This is just one example of how different underwriting policies from one bank to the next can dramatically impact your mortgage approval.
If you have any mortgage related questions, please feel free to reach out!
Craig Van Dolder
519 372 8524