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Housing and debt associated with housing are very romantic to Canadians. Before their quick decline caused by rising interest rates, housing prices in Canada (and around the world) reached all-time highs during the worldwide epidemic.
Homeowners have had access to increasing capital by using a home equity line of credit to draw from the value of their property (HELOC). But should they be welcomed or feared with rising debt levels in Canada, fluctuating housing prices, and rising interest rates?
How Do HELOCs Work?
Homeowners can borrow money from a HELOC at a less expensive rate than an unsecured loan. A homeowner may borrow up to 65% of their home’s worth under HELOC regulations. Homeowners only need to repay the interest accrued on the loan; there are no penalties for paying off the loan early.
With readvanceable mortgages, a HELOC and a mortgage are combined, allowing the borrower to keep making principal payments while only paying interest on the HELOC part.
According to the Bank of Canada, the total amount of these loans during the first quarter of 2022 was $737 billion. Stand-alone HELOCs are separate from your mortgage and function as revolving credit secured by your home. They generated in the first quarter of 2022 was $44 billion.
When Is a HELOC Appropriate?
Home equity lines of credit can be an excellent substitute for sure homeowners, but like with any kind of debt, they must be handled responsibly and not by everyone.
According to Scott Terrio, manager of the consumer insolvency at Hoyes, Michalos & Associates, “a beneficial usage is as a savings cushion if they haven’t already lost much of their value in HELOCs.” According to Terrio, self-employed folks or making a lot of money through commissions can benefit from a HELOC if they can pay it off.
When choosing to take on additional debt in the form of a HELOC, there are a few factors to think about:
- Can you comfortably afford the mortgage payment and other loan instalments, taking future interest rate hikes into account?
- Do you fully comprehend the conditions of your HELOC agreement?
- Are there any loans with higher interest rates that you could consolidate using your HELOC?
- Will the HELOC help you stay out of serious financial trouble?
- Have you considered how you’ll repay your HELOC once you take out a large chunk of money?
- Are you using it for a decision that could have a variable result, such as stock market investing?
You should select “yes” for all questions except the last one. The HELOC can be an effective instrument for you to pay off higher-rate debts or prevent a financial emergency, but you should utilise it carefully. Speaking with your lender about making regular payments on your HELOC is one approach to ensure discipline in your payback strategy.
As an alternative, include lump sum payments in your regular budget to ensure that the debt burden is gradually reduced.
An example of when using a home equity line of credit makes sense
The economy is doing well, and house prices in your neighbourhood are rising steadily. You’ve been with the same firm for five years and have solid credit and a reliable income. You wish to finance many home improvement projects with a home equity line of credit.
This is an instance where a HELOC might be a wise decision. You’re taking out loans against your house to make improvements, which raises the value of your house. As a result, the financing is a purchase of an existing asset.
In this situation, there is a benefit to using a HELOC in place of an unsecured loan. Budgets for home improvements might differ greatly, and what you anticipate spending may not necessarily be accurate. If you take out a loan and go over your budget, you might be forced to use high-interest credit cards to pay for the remainder of the project. On the other hand, if you take out a sizable loan but don’t use the money, you end up having to repay a debt you didn’t need.
On the other hand, a home equity line of credit gives you access to an open credit line that you can use whenever you need it. So, as you labour to improve your home, you only withdraw the money you need. The HELOC has a benefit over a standard loan because of this.
An example of when using a home equity line of credit would be unwise
You’ve racked up a $50,000 credit card debt. You work at a reputable company and have an excellent job, but news reports show the economy is unstable. Additionally, your income is commission-based, and sales are seasonal.
This illustrates a scenario where applying for a home equity line of credit could be overly dangerous. It’s dangerous since you have various signs that you might stop making payments. Your economy is fragile, and your income is unpredictable. You could miss payments due to a variety of circumstances. You risk the lender bringing a foreclosure case against you after that.
The aim of using a HELOC is the other problem. You just want to pay off your credit card debt in this situation. But in essence, you have simply changed an unsecured obligation into secured debt. They are unsecured credit cards. This implies that the creditor cannot seize your assets to recover their debt until they win a civil judgement in court. But if you use a HELOC to settle the loan, it becomes a secured debt. You run the danger of foreclosure if you go behind.
The HELOC shouldn’t be utilised carelessly as a quick source of cash, just like any other financial product. Carefully proceed after deciding whether you require a draw on your HELOC. If it is the most appealing alternative to assist you in achieving your objective, talk to your lender, carefully analyse your contract, and develop a repayment strategy.
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