Home Equity Lines of Credit (HELOCs) have become increasingly popular among Canadian homeowners, providing flexible access to funds using the equity built up in their properties.
It is very important to understand the pros and cons of HELOCs, particularly in light of high interest rates and the fact that they are demand loans that can be called by the bank at any time.
Pros of Home Equity Lines of Credit
1. Flexible Access to Funds: One of the primary advantages of a HELOC is its flexibility. Borrowers can access funds on an as-needed basis, making it an excellent option for ongoing expenses like home renovations, education costs, or unexpected emergencies. This flexibility allows homeowners to use funds when required and pay interest only on the amount they use.
2. Lower Interest Rates Compared to Other Credit Options: Despite the potential for higher interest rates compared to traditional mortgages, HELOCs often offer lower rates than other unsecured credit options like credit cards or personal loans. For homeowners with a strong credit history and substantial home equity, a HELOC can be an attractive alternative for borrowing funds at a lower cost.
3. Revolving Credit: A HELOC is a revolving line of credit, similar to a credit card. Once the borrowed amount is repaid, the available credit is replenished.
Cons of Home Equity Lines of Credit
1. Variable Interest Rates: HELOCs typically have variable interest rates tied to the prime lending rate, which can fluctuate with changes in the economy. While this means the interest rate could be lower during periods of economic growth, it also exposes borrowers to the risk of higher interest rates during economic downturns. The average rate today on a HELOC is 7.70% (Prime +.50%).
2. Risk of Over-Borrowing: The accessibility of funds through a HELOC can lead some homeowners to over-borrow, using their home equity for non-essential expenses. This behavior can lead to increased debt and financial strain, particularly if interest rates rise significantly.
3. Rising Interest Rates: With a HELOC, homeowners may face increased financial pressure when interest rates rise. As the interest portion of the monthly payment increases, borrowers might find it challenging to keep up with the rising costs.
HELOCS Are Demand Loans
One crucial aspect of HELOCs in Canada is their demand loan nature. Unlike traditional mortgages with fixed repayment schedules, banks have the right to call the loan due at any time.
Why might a bank call the balance of a HELOC?
1. Decline in Property Value: If there is a significant decline in the value of the property serving as collateral for the HELOC, the bank may decide to call the balance to mitigate potential losses.
2. Changes in the Borrower's Financial Situation: If the borrower's financial circumstances deteriorate, making it uncertain whether they can continue to meet their debt obligations, the bank might decide to call the HELOC balance to limit its exposure to risk.
3. Regulatory Changes: Changes in banking regulations or economic policies can also influence a bank's decision to call the balance of a HELOC. For instance, if there are substantial shifts in lending practices or if new regulations require banks to tighten their lending standards, they may reassess existing HELOC accounts and potentially recall the balance.
We will see new guidelines for certain types of real estate loans, including shared equity mortgages, reverse mortgages and conventional mortgages that are paired with revolving credit lines later this year. Currently, an owner can borrow up to 80% of the value of their property, but the new rules will lower that value down to 65% so borrowers who exceed the 65% will have to start paying back the amount outstanding if they exceed 65%.
If you would like a no obligation review of your current HELOC or have any other questions please email [email protected] or you can book a time for a chat here on my calendar. www.calendly.com/april-dunn
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.