HELOCs: beware of borrowing yourself into a never-ending balance
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The road to HELOCs (Home Equity Lines of Credit) is paved with good intentions.
After all, it’s easy access to credit, often at far lower interest rates than credit cards and other types of loans. Plus when used responsibly, a HELOC can provide the funds you need when life throws you an unexpected and very expensive curveball (leaky roof, appliance/car breaks down, etc.).
But having that kind of borrowing power can also take your finances off course if you’re not careful.
Just ask the more than three million Canadians who hold an average HELOC balance of $65,000 (that’s in addition to the balances owed on their mortgages, credit cards, and other loans). It’s no wonder that HELOCs have grown to become the single largest contributor to rising household debt in Canada. In fact, according to recent studies, Canadian HELOC debt is growing much faster than GDP.
So how do you prevent your HELOC debt from getting out of control?
That’s the $64,000, or in this case, $65,000 question—to which there is one simple answer: financial literacy. According to a study conducted by the Financial Consumer Agency of Canada, where 4,800 people put their HELOC knowledge to the test, the majority of participants scored below 50%.
The study also revealed that:
- 25% are making interest-only HELOC payments, putting them on the path to a never-ending balance
- 19% had borrowed more on their HELOC than they originally intended
- 18% did not know the full balance owed on their HELOC
- And younger borrowers (between 25 and 34) were more likely to struggle to afford a monthly payment increase of $100
That’s why when it comes to a HELOC (or any other type of loan), it’s important to fully understand the specifics of what you’re getting into.
You can start by learning the differences between the two types of home equity loans: fixed-term and line of credit. Both let you borrow money by leveraging the equity of your home, typically up to a maximum of 65% of your home’s appraised value (if you borrow from a regulated financial institution, such as a bank), or up to 80% with some other lenders (e.g. credit unions). However, there are subtle differences worth noting that could impact which borrowing option you choose to go with.
Fixed-term home equity loan (mortgage):
A home equity loan works much like a mortgage. This borrowing solution provides a one-time lump sum loan that gets paid back monthly with a fixed interest rate and within a specific time frame (typically 10 to 15 years).
- Fixed interest rate means payments will stay the same, even if rates go up
- Loan gets paid off within a set time period to prevent having a balance indefinitely
Things to keep in mind
- Monthly payments tend to be quite sizeable, the equivalent of taking on a second mortgage
- Home equity loans are based oncurrent market value; as the value of your property changes, so can maximum eligibility
Line of credit:
This borrowing option provides a revolving access to funds that you pay back like a credit card, complete with a minimum down payment and an adjustable interest rate (usually tied to the prime lending rate)
- Lower minimum monthly payments than the fixed-term option with payments as low as interest only
- Interest rates are typically lower than credit cards, providing instant access to a ‘low-cost’ borrowing option for a large amount of money(when used responsibly)
Things to keep in mind
- Since there is no set time frame for paying off the loan, there is a higher chance of owing a balance indefinitely
With great borrowing power, comes great responsibility and we can provide you with the expert advice you need to better handle that responsibility.
Whether you’re looking to navigate the terms of your existing HELOC, or want to switch to a borrowing option with a more definitive plan for paying it off, Educators Financial Group can help. No matter where you are on the pay grid, or what your pension income is in retirement—we offer a unique perspective into your world to provide you with smart borrowing solutions that work within your budget.
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