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by Janet Doyle
A home equity line of credit (HELOC) has become a popular way for Canadian consumers to access additional credit at a low interest rate; but with fluctuating real estate markets they can be a riskier option than people realize. Flexible repayment plans and high credit limits make home equity a useful tool for repaying debt or investing in home renovations; but changing housing prices and rising interest rates have pushed some consumers further into debt, and even to bankruptcy.
What is a HELOC?
A home equity line of credit is a secured loan against a house; using the property as collateral means less risk for lenders and they can offer a lower interest rate to the borrower. The amount of credit available depends on the homeowner’s credit rating, unpaid debts, the market value of the home, and the amount remaining on the first mortgage. Typically, the limit is set between 65-85% of the appraised value minus the outstanding amount on the mortgage.
Unlike a mortgage there is no set payment schedule to repay the principal with interest over a term; agreements can vary depending on the lender. Sometimes the borrower is only required to make interest only payments, while other agreements have a specified draw period and repayment period.
How is HELOC Different from a Home Equity Loan?
Both a HELOC and a home equity loan allow home owners to use their property as collateral and tap into home equity but have different terms. A home equity loan is paid to the borrower in a lump sum immediately while a HELOC allows you to withdraw smaller amounts up to your limit. Home equity loans are typically at a fixed rate; whereas a HELOC is subject to a variable rate. A home equity loan requires repayment to start immediately over a set time frame while repayment for a HELOC can be indeterminant or set into a specified withdrawal period; notwithstanding a HELOC is usually paid upon sale of the house or death unless transfer to a spouse or another residence is approved.
What Are the Risks of a HELOC?
Because HELOC’s have a revolving line of credit, a variable interest rate, and some require increased payments after the draw period has ended, this type of loan carries a number of risks.
Many people use HELOC’s for home improvements, emergencies, and to consolidate their debt payments at a lower interest rate, but the ballooning housing market has allowed Canadians to access large lines of credit which makes it easy for consumers to borrow more then intended. A mortgage is an investment in an asset that will (hopefully) appreciate in value, resulting in an increase in equity. If the value of the house subsequently drops, consumers may not see the expected return on their real estate investment. The variable interest rate means the loan is at risk for becoming more expensive; if interest rates continue to rise, consumers will end up paying more for the money borrowed and require an increased minimum payment to cover the additional interest charges. Additionally, if there is a downturn in the housing market, lenders may revise limits or call in loans – which they can do, at any time.
Unfortunately, for some consumers, a HELOC can become a revolving debt and there is a risk of spending the funds beyond their original intention. In 2017, the FCAC conducted a survey and subsequently published a report that identified potential issues for consumers including over-borrowing, debt persistence, and wealth erosion. 20% of respondents admitted they borrowed more then intended. The younger respondents were more likely to use the funds beyond their original reason for borrowing. 22% of the respondents used their HELOC for debt consolidation, and 29% used it to make payments on other debt (loans, credit cards, mortgage payments).
27% of respondents pay interest only most months or every month, and of those 40% are between the ages of 25-34. What’s most concerning is that 46% of those surveyed said they would struggle if their payment increased by $99 a month; this means any payment or interest rate increase could cause serious financial difficulties. With rising interest rates, Canadians are at risk for becoming stretched too thin by unaffordable debt payments. An emergency, job loss, or health issue could force additional debt or affect the ability to repay the debt, forcing consumers to look for options for debt relief.
The biggest issue for consumers is that a majority of borrowers don’t understand the terms and conditions of the loan or have a plan for paying it back. If you’re considering a HELOC, ensure you take some time to think about it and go over the fine print before signing. Understand the payments and develop a plan to pay back the debt.
If you have an existing HELOC and are struggling to make debt payments or receiving calls from collectors, your home could be at risk for seizure. Doyle Salewski can put a stop to legal action from creditors if you act sooner than later; contact our office for a free consultation: firstname.lastname@example.org or 1-800-517-9926.