HELOCs may sound like a great idea, but they are often overrated. A home equity line of credit is a very easy way to get money, yes, but that could be their only advantage, as many debt-ridden Canadians are finding out. The latest statistics show that 36 per cent of Canadians have a home equity line of credit, but the majority of them do not know very much about how these credit lines work. It is also true that on some occasions HELOCs offer low interest rates and flexible borrowing terms. The low rates are contingent on the fact that people use their real estate property as collateral. But what happens when the rates increase?
Experts claim that these credit lines encourage people to spend more than what they normally would. What are HELOCs most often used for? Usually they are used to make home repairs, buy a car, make a down payment, or go toward a child’s tuition. Some rather frivolous reasons include going on vacation. What is also surprising is that a large number of people who get a HELOC do not even use it. The minority of those with a HELOC admit to having read the fine print and/ or having consulted a lawyer before making the decision to get it.
Sometimes HELOC agreements are such that you are prevented from using your credit card or your credit rating is affected. In some cases, you cannot sell your home if you have not paid your HELOC back because the bank has claims to it. This is something many Canadians are finding out the hard way, too. Few people know the important things about a HELOC, such as the fact that the bank you get it from puts a mortgage on your home (or a second mortgage if you already have one). Then, any credit card consolidated under the HELOC could be canceled when you pay the credit line off. What is more, having a HELOC can make it difficult to get a loan from another financial institution (The Globe and Mail).
With a HELOC, the lending institution sets a maximum amount of money that you can get, and the full amount is not paid in advance. This is how a HELOC differs from a home equity loan. When you get a HELOC, you are given up to 15 years to use it, and you only pay interest during this period. At this time, it is impossible to refinance or sell your home, of course. You can repay the loan without penalties in this period. If the lender demands that you pay at the end of these 15 years, you will have to refinance. If no such demand is made, you have to start repaying the loan gradually (Canada Trust).
It should be noted that the interest rate on a HELOC is calculated on a daily basis, as is done with credit cards. Interest rates fluctuate, and this goes with a high degree of risk. All changes in the prime rate affect the HELOC, which in turn affects your mortgage payments. You cannot establish a fixed rate with a HELOC.