Here are some things to know before you apply for a loan or home equity line of credit
Equity is the difference between your home’s current value and what you owe. There are two ways you can borrow money from your equity: a home Equity loan and a Home Equity Line of Credit (HELOC). Canadian interest rates are still low and property prices stable or rising, so borrowing money from the equity of your home can be a good option to finance debt consolidation, renovations or starting a new business.
Financial institutions favor home equity loans and Home Equity Loans. This is because, if you can’t repay the amount borrowed, they will have your property as security. Credit lines are popular with consumers as they offer the ability to borrow money anytime, at a lower rate than credit cards. HELOCs have low minimum payments. If someone pays down the amount they owe, funds will become available again for them up to a certain limit. HELOCs have become a popular option for borrowing due to their favorable interest rates on line of credit, revolving credit access, and the ability to draw large amounts at will.
Are HELOCs or Home Equity loans right for me?
A line of credit, or one-time equity loans, can be used to fund anything from home renovations and big ticket purchases. You can decide how much and for what purpose. A home equity credit line can be an excellent financial tool, provided you keep your payments on time and are disciplined. For many people, however, a credit line can help them avoid getting into debt.
These are the things to consider before you decide to take out a mortgage or home equity credit line (HELOC).
Home Equity Loans, Mortgages, and Home Equity Lines of Credit
What is the Difference?
HELOCs, mortgages, and home equity loans all use your house as security to repay the debt. You can consolidate debt with any of these three options. These are the differences.
What is a Mortgage?
A mortgage is a loan to purchase real property. The mortgage relies on the collateral of the real estate to secure the loan. This means that the lender has the legal right and authority to take the property if the borrower defaults on the loan. Interest is charged on top. Mortgage payments are usually combined to repay the principal and its interest.
How to use your Home Equity
What is a home equity loan?
Home equity loans are also known by the second mortgage. They allow homeowners to borrow money against the equity of their home. The loan is a lump sum that you can use however you wish. The loan can be used for home renovations, college tuition, and medical bills. Your home is used as collateral, just like a mortgage. The loan will be repaid over time. Depending on how the lender structures the loan and what terms you agree to, your interest rate could be fixed or variable.
What is a Home Equity Credit Line?
A home equity credit (HELOC), is a loan that leverages the equity of your home. The loan comes in the form of an unsecured revolving credit, and not a lump-sum. This type of credit allows for greater flexibility as you have access to a larger pool of funds. And again, you are free to choose how you use it. You could use it for emergency situations, debt consolidation or to fund a home renovation project.
Your line of credit payment terms are also flexible. The loan agreement will allow you to pay only the interest on a HELOC. You don’t have to repay what you borrowed. Also, variable interest rates for lines of credit are often lower than credit card interest rates.
Credit lines work in the same way as credit cards. You only pay interest on what you use and you make monthly payments. If you get approved for a HELOC of $25,000 but only borrow $5,000 then you only need to pay interest.
How revolving credit lines work
Credit cards and lines are both excellent examples of revolving credits. These allow you to borrow money up until a pre-approved limit. Each time you make a repayment, your account will remain in good standing and you’ll be able to access the credit again.
You have $20,000 left if you use $20,000 from your $40,000 credit card. You can then use your $30,000 credit to make a $10,000 repayment. This will reduce the interest you pay each month. You now have $30,000 to spend on home improvements, new furniture, or to pay off high-interest credit cards debt. Home equity lines of credit are similar to credit cards. They can make it tempting to spend money that you don’t have.
Revolving credit can cause serious debt problems
A credit-dependent lifestyle can lead to financial problems and serious debt problems. Revolving credit has no monthly fixed payments. A minimum payment is all that’s required. You can lose track of your debt or pay too much without a fixed monthly payment.
Even if your credit line requires only interest payments, the problem could be even worse. If you become accustomed to only repaying interest, you may end up with more debt than you realize. You don’t need to pay them forever, no matter how low the line of credit interest rates.
Before you buy something with a home equity line of credit, decide if it is a necessity or want.
Before you use your home equity line to purchase a property, make sure that you have the cash available. If you are able to easily pay for the purchase with money from your chequing accounts, then it is best to do so. HELOCs cannot be used to pay for daily expenses.
If the expense is large and you require credit to purchase it, you should determine whether you have the funds available to cover it. Also, consider how fast you can pay it back, taking into account that interest rates are subject to change.
It may take you many years to pay for that purchase. Give yourself some time to consider it. It may be that after some reflection and time, you will realize that it is not something you actually need or want.
How to manage debt using low-interest loans and revolving credit lines
There are ways to avoid problems with revolving debt and living credit-dependent lives:
- Talk to your lender to arrange automatic monthly payments covering the principal and the interest. You’ll be able to have your credit line paid down in a specific time period.
- Automate payments to pay more than just interest by setting up online or internet banking services.
- Make a household budget and keep it up to date. This budget should cover all of your monthly, irregular and seasonal expenses. These are the “seasonal expenses” that often get paid with a line credit.
- If you have any questions, don’t hesitate to ask for assistance. We are happy to help you if you’re struggling to get ahead because you may be in debt.
