The Home Equity Line of Credit (HELOC) is considered to be one of the more preferable types of debt. With its lower interest rates and selective criteria for approval, it can seem like the wiser way to use credit. However, due to its guilt-free nature it can also be one of the most dangerous types of credit. Before you know it, your mortgage payments are going up at renewal time instead of down. Credit Canada credit counsellors often see HELOC use both good and bad.
Here are three questions to ask yourself before dipping into your HELOC.
Can you afford the interest payments?
Once you start using your HELOC, you will need to pay at least the interest on it each month. The low interest rates may make borrowing from your HELOC seem innocent enough. However because people tend to use their HELOC for major purchases, such as home renovation projects or a child’s wedding, they usually borrow thousands of dollars at a time. Therefore, the new monthly payments can end up being quite high, sometimes even in hundreds of dollars! This leaves little room to put additional funds to pay off the debt itself. You could end up paying interest on this debt for possibly years to come. If you still have not paid it back by the time your mortgage comes up for renewal, it may be rolled into your mortgage resulting in higher mortgage payments. Not very progressive.
Is the purchase worth the cost plus interest?
When making a purchase using your HELOC, consider whether the purchase is worth its original cost plus many years worth of interest payments. If you have a leaky roof that needs to be fixed right away, your HELOC could be a lifesaver. However if you absolutely must have kitchen granite counter tops, ask yourself if they're worth their quoted price, plus a few hundred more in interest. It might be better to take your money and put it into a savings account to fund your dream kitchen and add to any debt problems.
Is there a cheaper way to finance your purchase?
The convenience and availability of the HELOC makes it a popular choice for covering major expenses. However there may be cheaper alternatives out there for buying a bigger family vehicle or repairing your home. For example, many car dealerships will offer 0% or low interest financing if you have good credit. Some people will be able to get a loan from their parents to make repairs to their home. Evaluate all your options before deciding whether your HELOC is the best source of financing for your expense.
A Home Equity Line of Credit can be a good thing to have in case of an emergency, such as unemployment or the sudden death of a family member. Just be sure to use it sparingly and with plans to repay it as soon as possible. Your HELOC may have a low interest rate, but remember it is secured to your home, so if you ever fall behind on payments you will be putting your home at risk too.