One HELOC way to home equity havoc
Using the value of your home as line of credit has its pitfalls
What the heck is a HELOC?
The term HELOC refers to turning your house into a giant credit card with extremely low interest rates. If you think that sounds like a good deal, you’re not alone.
HELOC is the acronym for a Home Equity Line of Credit. Many lenders will allow you to borrow money against the worth of your house at a much lower interest rate than on your credit cards or if you were using a line of credit that wasn’t “backed” by anything.
The idea is that banks and credit unions can safely assume lending you money is relatively low risk because you can always sell your house to pay your debts.
Home equity is basically the difference between what your house is worth and how much (if anything) you still owe on your mortgage.
For example, if I purchased a home for $300,000, paid a $60,000 down payment, and then faithfully made my monthly payments for 10 years, I might have whittled my mortgage down to $165,000 or so. If my house was in an ice-cold housing market and hadn’t risen in value at all during those 10 years, I would now have roughly $135,000 in home equity.
If I lived in a major Canadian urban centre over the past 10 years, my home is now probably worth at least 25 per cent more than I paid for it though; therefore, I’d have more like $235,000 in home equity. Therein lies the HELOC trap. As a Canadian millennial, I could be excused for thinking that the value of houses only goes up — and that it always does so quite drastically. If you follow that line of reasoning to its logical conclusion, there should be no harm in borrowing against the growing equity in your home, because as long as the value of the house goes up faster than you borrow against it, things will be fine. Of course if interest rates suddenly rise, home values fall, and many other bad things happen — you could be caught financially skinny dipping when the tide goes out.
According to the Canadian Association of Accredited Mortgage Professionals (CAAMP), 27 per cent of people with mortgages in Canada in 2014 had a HELOC. Of those that had one, 90 per cent had an outstanding balance and the average amount outstanding was $57,000.
HELOCs can be great financial tools if understood and used properly. If they are simply seen as the quickest way to marble countertops, a new boat, or that luxury vacation you’ve always wanted ... Well, just remember, the tide always goes out eventually.
A home equity line of credit or HELOC can make it all too easy to overextend yourself.