Debt Relief Solutions: Home Equity Lines Of Credit (HELOC)

Multiple debt payments, especially those with high interest rates, add up fast. There is no greater frustration than when you make your payments and they make no noticeable change to your balances. Even with good financial habits, that debt cycle is hard to escape.

However, you could use home equity to ease that burden. A Home Equity Line of Credit (HELOC) or a home equity loan can lower your payments and interest rates to manageable levels.

Let’s explore the benefits, drawbacks, and alternatives of a HELOC so you can make an informed decision on your debt.

Home Equity Lines of Credit

A Home Equity Line of Credit lets you use the equity in your house as collateral. Home equity as security typically results in a lower interest rate and a required payment on interest only. You achieve those favourable terms because the bank can get its money back by seizing the value of your home.

How does a Home Equity Line of Credit (HELOC) work?

Most lenders allow you to borrow up to 80% of the value of your home. Depending on your mortgage, you can use some of your home equity as a mortgage and the balance as a HELOC. If you only want a Home Equity Line of Credit, you can set one up for a maximum of 65% of the value of your home.

For example, if the value of your home is $850,000, the maximum combined mortgage and HELOC amount you can get is $680,000. You can divide the $680,000 between your mortgage, HELOC, and other credit products (a mortgage of $520,000 and a HELCO of $160,000). And if you don’t want a mortgage but only a HELOC, you can have one that is a maximum of 65% of the value ($552,500).

Your payments are typically the interest you owe for the month. Lenders use the Bank of Canada’s prime lending rate to set interest rates. They can be as low as prime plus one. So, if the prime rate is 4% and your HELOC rate is prime plus one, your rate will be 5%.

HELOC rates are variable and will change as the prime rate changes. If the Bank of Canada increases or decreases the prime lending rate, your HELOC rate and payment will increase or decrease, too.

How can a HELOC help with debt management?

The flexibility, lower interest rates, and ease of use make the Home Equity Line of Credit an appealing borrowing product. You can use it for almost any capital project such as home renovations, education expenses, or emergencies.

In particular, a HELOC can help with debt management and to avoid bankruptcy, for several reasons:

• Rate reductions: You can reduce interest costs with lower rates on unsecured debt.
• Consolidation: You can combine all your debt into one lump sum with one payment
• Flexibility: The minimum payment can be the interest alone.
• Repeat and continuous borrowing: The limit is revolving, so as you pay off your balance you can borrow against the available credit again. It provides a constant source of funds.

How to prepare and close a HELOC

Closing a Home Equity Line of Credit (HELOC) involves several steps, from assessing your financial situation to submitting the applications. Here are some common considerations:

• You must have at least 20% equity in your property
• You must submit a credit application and submit to a credit check
• You must confirm property ownership and provide proof of income, employment, investments, and debts
• The property’s value may need to be confirmed, often by an appraisal
• A lawyer (or notary) should handle the legalities
• If you are refinancing your mortgage or buying a home, you may have to pay an appraisal and legal fees, and penalties may apply.

How a HELOC Can Harm Your Finances

There are possible risks with a HELOC. Awareness of these risks can help you decide whether a HELOC is the right choice for your financial situation.

●       Risk #1: You lose your home: Security for any loan can give you better rates, terms, and conditions. However, a home is also where you live. If you cannot make your payments, your lender can take action to seize and sell your house. You could lose your home if you fail to make payments.

●       Risk #2: The bank can change the loan terms: Your financial institution can alter the terms and conditions of your HELOC. That includes the line of credit rates or your repayment terms. They can also demand you pay off your HELOC in full. You will be notified in writing of these changes, but can still put you in financial jeopardy.

●       Risk #3: Interest rate changes: Your interest rate will change as the prime rate changes. If the Bank of Canada reduces the prime rate, your rate will decrease, and you could pay less. The Bank of Canada can also increase rates rapidly. The prime rate increased from 2.45% in February 2022 to 7.20% in July 2023,1 and interest-only HELOC payments rose significantly during that time. The higher HELOC payments have added to many Canadians’ financial burdens.

●       Risk #4: You could owe more than you own: The value of your home determines how much you can borrow. If your home value declines after you set up a HELOC, you could end up owing more than the value of your home. This situation, known as negative equity, means you could be in debt even after you sell your home.

●       Risk #5: A never-ending debt cycle: It’s easy to access credit through a HELOC. That accessibility might tempt you to use it to cover basic living expenses or items you can’t afford, like luxury vacations. A HELOC to cover living expenses will likely keep you in debt. In addition, making only the minimum interest payments will ensure you never pay off your HELOC.

Alternatives to a Home Equity Line of Credit

If you have debt, there are some alternative solutions to a HELOC:

Debt consolidation loan

You can get a single loan to pay off your multiple forms of unsecured debt. That consolidated credit loan can lower your combined interest rate and give you one payment to make each month. Your lender will set up your payments to ensure you pay off your loan within a specific time frame.

Debt consolidation mortgage

You can use the available equity in your home to combine your debts into your mortgage. There are several benefits to using a home equity loan or remortgage instead of a HELOC:

• You’ll have one payment
• You can get a fixed-rate mortgage, which means your interest rate will remain the same throughout the mortgage term
• You reduce your debt by paying off some of the amount owing, not just the interest.

There are some significant drawbacks to combining your debt with your mortgage.

• You still place your home at risk
• Mortgages can take 25 years or more to pay off, which increases the interest costs on your debt
• The application process and fees can make these mortgages difficult to set up

Consumer Proposal

Consumer Proposals are a government-approved debt relief program that a Licensed Insolvency Trustee arranges for you. A Consumer Proposal offers multiple advantages:

• It can reduce your debt by up to 80%
• You get one monthly payment
• You can have up to five years to pay off your debt
• It is legally binding
• After filing your Consumer Proposal, all collection activity, legal action, and interest on your debt must stop
• Your assets are not put at risk because you keep all your assets
• Your payments include all fees

One significant drawback of a Consumer Proposal is that it does hurt your credit rating.

Help With Debt Consolidation

A Home Equity Line of Credit is a viable debt relief solution. And in the correct scenario, it can help you escape the debt cycle. If you need advice on moving forward and getting rid of your debt, call us at 1-866-317-8331 or contact us online for a free consultation. Our Licensed Insolvency Trustees at Chase and Associates will work with you to help you get out of debt without risking your home.