Home equity lines of credit (HELOC’s) are a popular way for Canadian homeowners to borrow money. It’s not hard to see why, they have low interest rates and can be used for basically anything. There are no specific limits on what a HELOC can be used for.
But what are they exactly, and how should you be using them though?
Using it to help cover monthly expenses is not a great idea. However, there are good ways to use this type of credit, which, can increase the value of your house. And, of course, there are also irresponsible ways to use a HELOC that can actually get you into more debt. So, what is a HELOC, and how can you use it to help you?
HELOCs are a type of loan that allows homeowners to borrow against the equity in their home. It works like a credit card, where the borrower has a revolving line of credit they can draw from as needed.
You can find the amount of equity in your home by subtracting what you owe on your mortgage from your home’s market value. For example, if your home’s market value is $500,000, but you still owe $400,000, your equity is the difference: $100,000.
In most cases you can borrow up to 65% of the equity on your home, in some cases it can be up to 80%. HELOCs have variable interest rates, which is important to keep in mind during this time where interest rates are in flux. The interest rate on a HELOC is often much lower than of a typical credit card or an unsecured line of credit though.
A HELOC is a secured debt, which means it is tied to the asset of your house. If you fail to make payments, your house can be foreclosed.
That said there are responsible ways to use a HELOC to increase the value of your house, or to help you pay down debt.
As anyone who has ever done a home renovation will tell you, they are EXPENSIVE and full of unforeseen challenges.
This is why one of the most common ways to use a HELOC is for home renos. HELOCs allow people to borrow large amounts of money at a low interest rate, making it ideal to pay for big construction projects on their home.
Using your HELOC to help pay for renovation is a responsible way to use the HELOC for one simple reason: doing renovations on your home will increase the value of your house. Using your HELOC to pay for the renovations is an investment that should pay you back in the long-term if you choose to sell your house.
Debt consolidation means paying off multiple debts with the help of another type of credit with a lower interest rate. You are essentially transferring many debts into larger debt, with one monthly payment. And since HELOCs come with interest rates lower than the average credit card or other lines of credit. If you have debt from credit cards or an unsecured line of credit, you can tap into your HELOC and use money from it to pay the higher interest rate debt down and thus avoid the high interest fees.
Using a HELOC to help pay off debt is a great use of the financial product. But there are some things a HELOC should never be used for.
While a HELOC may work like a credit card, with a set limit you can borrow within, you should not use it like a credit card. Buying a new home theatre system, or a trip is not how it should be used.
Using a HELOC to pay for non-essentials is a sign you’re spending beyond your means. While the interest rate on a HELOC is lower than of a credit card, it is still a form of debt. Using debt to buy things you want without being able to pay it off quickly only creates larger financial problems down the line.
Education is expensive. Many families struggle to save up the money for college or university education. With the low interest rates on HELOCs, it can be tempting to use one to afford the payments. The problem here is a HELOC is tied to your house. If you can’t afford the payments, you can lose your house.
A better option is good old fashioned student loans. A student loan is a form of installment loan, where you make regular payments for a set period of time until the debt is paid off. You can make lump sum payments too to lower the debt faster. While the HELOC may have a lower interest rate than many student loans, student loans themselves do not have particularly high interest rates to start. The federal government of Canada recently removed the interest it previously charged on student loans.
With a second mortgage instead of borrowing funds as you need them as you would with a HELOC, it is a lump sum amount deposited directly to your bank account.
As the name implies, a second mortgage is an additional mortgage on your home. You can borrow up to 80 per cent of your home’s value, minus what is still owing on your first mortgage. You are then responsible for making two regular mortgage payments.
The benefit of a second mortgage is you’re obligated to make regular monthly payments. Just like your mortgage or any other bank loan, your payments chip away at the original loan amount. The downside is that you may be taking on more debt than you actually need.
Like a second mortgage, these options let you borrow up to 80 per cent of your home’s value minus what you still owe on your home.
Whichever method you choose, your loan amount will be added to your mortgage balance. You may or may not end up with a lower interest rate on your mortgage, but your monthly mortgage payment will increase.
Just because you can borrow up to 80 per cent of your home’s equity doesn’t mean you should. Borrow only what you can afford to pay back. If you’re struggling to pay back your HELOC or realize it won’t help you get out of debt, a Licensed Insolvency Trustee can help you review all your debt relief options.
The first consultation with one of our Trustees is completely free.