The Learning Centre:
Have a HELOC? Beware of borrowing yourself into a never-ending balance.
The road to HELOCs (Home Equity Lines of Credit) is paved with good intentions.
After all, it’s access to easy 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 curve ball (e.g. 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.
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.
- 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 on current market value, which means the value of your equity fluctuates with the market.
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; you only have to make interest payments.
- 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.
Due to a climate of rising interest rates and household debt levels, banks are starting to tighten their rules for those applying for a new mortgage while carrying a HELOC. What this means is that most banks are adopting their own financial ‘stress test’ to see if borrowers can afford making payments based on their HELOC limit, regardless of a zero balance owing.
Naturally, with great borrowing power, comes great responsibility—and the more you know, the better equipped you will be to handle that responsibility.
So if you’re looking for a little guidance on navigating the terms of your HELOC, or want to switch to a borrowing option that provides you with a more definitive plan for paying it off, Educators Financial Group is here to help.
From pay grids to pension plans (OTPP/OMERS), we understand your cash flow in your working years and in retirement. This provides us with a unique perspective to offer you the kind of borrowing options and solutions that work within your budget—because borrowing should always have a specific purpose, along with a specific action plan to pay it off.
For more great tips to enhance your financial literacy, sign up for Your Guide to Lifelong Earning for Educators. And be sure to check out our suggested topics below for further educator-specific information and insights.
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The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting or professional advice. Please ensure to consult your accountant and/or legal advisor for specific advice related to your circumstances. Educators Financial Group will not be held responsible or liable for any losses, costs, damages or expenses incurred by reason of reliance as a result of the aforementioned information. The information presented was obtained from sources that are believed to be reliable. However, Educators Financial Group cannot guarantee their completeness or accuracy.