Homeowners risk falling into debt trap: 7 hidden dangers of the new federal secondary suite mortgage program

Requirements of the new federal government secondary suite funding program

To qualify for this new mortgage refinancing product, the homeowner or a close relative must occupy the secondary suite or another unit within the principal residence; however, the government has yet to specify how this requirement will be enforced.

Plus, there is a maximum of four units allowed on the property, and funding for the improvement of the property cannot exceed the maximum value of the property, which is capped at $2 million.

Aside from the restrictive requirements in qualifying for this new funding, homeowners need to realize the potential drawbacks of accessing a large portion of the equity in their home. In particular, here are seven key dangers to be mindful of.

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7 disadvantages of the secondary suite mortgage program for current homeowners

Here are seven red flags that homeowners should be aware of when considering using the federal government’s new secondary suite financing program:

# 1. Higher interest costs

When homeowners borrow a significant portion of their home equity — whether through a home equity line of credit (HELOC), refinancing or this new secondary suite refinancing program — lenders may charge higher interest rates. Borrowing above 80% of the home's value is seen as a higher risk by lenders, which can translate into costlier borrowing terms.

By refinancing your home to access more equity, for example, you are forced to take on a higher loan-to-value mortgage — otherwise known as an insured mortgage. Insured mortgages require lenders to take out mortgage loan default insurance — which serves as protection should a borrower default on their home loan. However, lenders rarely absorb the premiums for this insurance and, instead, pass on this cost to the homeowner.

For instance, if you choose to take advantage of the federal government’s new secondary suite financing program and assuming your mortgage is up for renewal on January 15, 2025, when the program comes into effect (and to keep math simple, eliminate fees charged for breaking your mortgage), then you could unlock as much as $1.8 million in mortgage funds. At the current average five-year fixed rate for an insured mortgage (of 4.19%), that equates to a mortgage payment of just over $4,825 each month.

For some homeowners, this will help unlock equity in their home that could be used to help pay down debt. Assuming mortgage rates don’t climb in the next five years (making it more expensive when it comes time to renew the mortgage).

For others, it may be a slippery slope resulting in higher interest costs and overwhelming debt.

No matter what you choose, it’s best to comparison shop for the best mortgage rates, read the mortgage terms so that you know the conditions match your needs, and to truly examine your household budget to confirm that any additional debt you take on is combined with a realistic strategy for paying off the loan.

#2. Increased debt load

Accessing home equity results in taking on more debt. If a homeowner draws out equity to pay for expenses like renovations, education or other investments, they increase their debt burden.

While this new mortgage product is specifically for renovations to help create an income-producing component, that doesn’t mean the debt won’t cost you.

To be sure it makes sense, investigate what rental rates are typical in your market — and then have a serious discussion with friends and family about the money they’ll contribute if they end up living in the suite.

Remember, with higher debt levels, repayment can become a challenge, especially if income levels decrease or expenses rise.

#3. Vulnerability to market changes

If housing prices decline, homeowners who have borrowed a large portion of their home equity may owe more than their property is worth. This is known as negative equity.

While most homeowners can withstand market fluctuations, homeowners with negative equity enter into dangerous territory if they need to sell or refinance the home during a market downturn.

For most property owners, the best defence is to maintain enough equity in the home to insulate you from being forced to sell at a loss. While this buffer depends on your personal circumstances, for most people, it’s having at least 10% equity in the home.

#4. Reduced financial flexibility

Borrowing above 80% of a home’s value leaves little room for future refinancing options, as many lenders impose limits on how much equity you can access — and this can reduce future financial flexibility.

This means if interest rates rise or homeowners need funds in the future, they may be unable to access additional equity. So, you may have fewer options for consolidating debt or accessing emergency funds — and these restrictions on getting funds often means paying more when you do find funding options.

#5. Risk of foreclosure

With higher debt comes the risk of default. If homeowners face financial hardships, such as job loss or unexpected expenses, they may struggle to keep up with mortgage payments and repayments on their HELOC or additional loans. This increases the risk of foreclosure on the home or on other higher-value assets.

#6. Impact of rising interest rates

If part of the equity is accessed via variable-rate loans, such as HELOCs, a rise in interest rates can lead to higher monthly payments. Given the volatility of interest rates, this could significantly increase debt servicing costs over time. This means you’ll pay more for longer just to get money now.

#7. Impact on retirement plans

Many Canadian homeowners plan to use their home as a major asset in their retirement planning. By borrowing a large portion of your home’s equity, you may be eroding your long-term financial security. If too much equity is used during working years, there may be little left to downsize or use to fund retirement.

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Bottom line

While the federal government’s secondary suite mortgage program offers an enticing opportunity to access home equity and generate rental income, it is essential for homeowners to approach it with caution. The potential financial benefits could be overshadowed by the risks of rising debt, interest rates, and diminished long-term financial flexibility. Homeowners must carefully assess their financial situation, consider future market changes, and ensure they are prepared for any potential downsides, such as negative equity or reduced retirement security.

By weighing the pros and cons and implementing a solid repayment plan, homeowners can avoid falling into a debt trap while maximizing the benefits of this program.

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