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Is a Home Equity Line of Credit (HELOC) right for me? If you own a home and want cash available to use at your convenience, then yes, it is! It’s a great loan because you only pay interest on the amount of cash you use. Moreover, you can use the cash for anything you want. That can be for investing, for medical bills, personal projects, education, and so on… All the lenders usually require is for you to have an average credit score and income (self-employed borrowers can get HELOCs!). You can access the cash right from your debit card.
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The Facts About HELOCs:
CBC.ca wrote about a study released on January 15, 2019 by the Financial Consumer Agency of Canada (FCAC - a federal agency that promotes financial education), and the study found "a lack of understanding among consumers of how these lines of credit work."
What Is A HELOC?
Let's clarify things. HELOC = home equity line of credit. A HELOC is simply a mortgage secured against the equity in a home. More specifically, the mortgage funds are made available as "revolving credit."
"Revolving credit" means the loan amount (the mortgage amount) can be withdrawn by borrower whenever the borrower wants, and also repaid and redrawn again (and continuing in this manner) until the mortgage term expires.
But make no mistake: as a loan secured by a home, a HELOC is a mortgage. If you have a mortgage (that is, a first mortgage against your property) and then later get a HELOC in addition to that first mortgage, then your HELOC is technically a second mortgage.
Some Basic Facts:
- Banks offer HELOCs. Smaller mortgage companies and private lenders usually don't offer HELOCs.
- Borrowers can borrow up to 65% of a home's appraised value.
- Banks tend to offer HELOCs as their default credit option to a borrower who has home equity.
- HELOCs are immensely popular: over 3 million Canadians have HELOCs.
- The average amount borrowed is $65,000, but ~25% of borrowers have balances of over $150,000.
- 50% of borrowers say they use the money for renovations, and 22% use it to consolidate debts.
- Borrowers also use HELOCs for vehicle purchases and daily expenses.
The HELOC's Advantages:
- If you own a home, have equity available, have a good credit score, and have income that is reasonably flowing and predictable, then HELOCs are easy to get.
- HELOCs vs. first mortgages: with a HELOC you have the money available to you, and you only pay interest on what you borrow. Talk about convenience!
- HELOCs vs. second mortgages: HELOCs are a much cheaper source of credit. Second mortgages are usually from private lenders which require lending fees in addition to higher interest rates. Second mortgages are also normally 1 year in duration, sometimes 2 years, extremely rarely 3 years. Many people keep their HELOCs for over a decade.
What Borrowers Need To Know:
- The banks can raise the rate of a HELOC whenever they want to.
- The banks can demand the full balance of a HELOC whenever they want to.
- You must pay fees in order to transfer a HELOC to another bank.
- The banks can raise or lower your HELOCs credit limit whenever they want to.
- The annual interest rate of a HELOC is based primarily on the Bank of Canada key interest rate. This means that when the Bank of Canada interest rate rises, so will the rates on HELOCs. This means the HELOC gets more expensive if Canada's interest rate rises. But even if the Bank of Canada's interest rate doesn't rise, any bank can still change its "prime rate" which it uses to set the rates for its products, like HELOCs.
What Borrowers Should Do:
- Keep track of how much you borrow. 19% of borrowers surveyed borrowed more than they intended. 18% of borrowers do not know the full balances on their HELOCs.
- Pay it down. Many Canadians are simply not even trying to pay off their HELOCs. Most borrowers don't repay their HELOCs in full until they sell their home.
- Pay down the principal and the interest. 25% of borrowers surveyed said they only made the monthly interest payments, nothing more.
- Don't borrow more than you can handle. Borrowers can end up struggling with debts later on.