Debt Relief Experts
A Home Equity Line of Credit (HELOC) can look like a tempting solution if you’re trying to manage debt. After all, it usually comes with a lower interest rate than credit cards or personal loans, and you can access funds whenever you need them. However, because it’s secured by your home, a HELOC carries unique risks. Below, I’ll explain how a HELOC works, its advantages, and the potential downsides – so you can decide if it’s the right choice for you.
Table of Contents
What Is a HELOC?
A Home Equity Line of Credit is a revolving line of credit that’s secured by the equity in your home. Equity is the difference between the market value of your home and the balance remaining on your mortgage. With a HELOC:
- You can typically borrow up to 65% of your home’s value.
- The bank sets a credit limit, and you only pay interest on the amount you actually use.
- Interest rates are often variable, usually expressed as “Prime + [a certain percentage].” This means your rate, and therefore your monthly payment, can rise if the Bank of Canada increases rates or if your lender changes the terms.
Because a HELOC is tied to your home, it’s considered “secured debt.” If payments aren’t made, the lender has the option to foreclose on your property. That’s why it’s important to understand the risks of a home equity line of credit before signing up.
Advantages of a Home Equity Line of Credit
- Lower Interest Rate: Compared to unsecured debt like credit cards or personal loans, a HELOC typically offers a much lower interest rate. This can make monthly payments more manageable in the short term.
- Flexible Access to Funds: A HELOC functions like a revolving credit account. You can use as much (or as little) of your available credit as you need, and you don’t have to reapply each time.
- Convenience: You have ready access to funds for home repairs, renovations, emergencies, or other short-term needs.
- Possibility of Debt Consolidation: Because the rate is lower, you might use a HELOC to consolidate high-interest balances, saving money on interest if you keep your overall debt under control.
Risks & Negatives of a HELOC
Are HELOCs a bad idea? They aren’t always, but there are several reasons why you shouldn’t get a HELOC without carefully weighing the risks:
- Variable Interest Rates: HELOC rates fluctuate. If prime goes up, so does your interest rate, potentially increasing your monthly payment.
- Credit Score Impact: Carrying a large HELOC balance or missing payments can hurt your credit score, since this revolving debt is reported to Canada’s credit bureaus. High utilization on your HELOC signals higher financial risk and may lower your score, making future borrowing more expensive.
- Callable Debt & Changing Terms: A HELOC is a “callable” debt, which means the bank can decide to reduce your credit limit or require principal payments anytime. You have no guarantee that your current terms will remain in place.
- Secured by Your Home: If you fail to repay, the lender can force the sale of your house to recover the debt. This is especially concerning if you’re already juggling credit cards, car loans, or other obligations.
- Risk of Over-Borrowing: Large credit limits and interest-only payments can be dangerous. It’s easy to rack up a big balance without making a dent in principal.
- False Sense of Security: A lower rate can hide the fact that you’re still accumulating debt. If you also keep running up your credit card balances, you’ll dig yourself deeper into a financial hole.
- House Value Fluctuations: If your local real estate market drops, you could end up owing more than your house is worth (often called being “underwater”). Selling the home becomes difficult, and you’re stuck with secured debt that can’t be cleared by a simple sale.
Is a Home Equity Line of Credit a Good Idea?
Whether you should take out a Home Equity Line of Credit depends on your personal financial situation.
- If you have minimal debt and stable income, a home equity loan can be a convenient, flexible borrowing tool.
- If you’re already juggling high-interest debt, a HELOC may only add risk rather than address the real root of the problem.
Ask Yourself These 5 Questions
- Could You Handle a Major Life Change Like Relocation or Divorce? If you had to sell your home, would you recover enough to pay off the mortgage, HELOC, and any realtor or legal fees?
- Could You Still Afford HELOC Payments If You Lost Your Job? Make sure you have enough savings or a backup plan to handle repayment if your income suddenly drops.
- What If Your Home Value Decreased? Housing markets fluctuate in the short term. If your property is worth less than what you owe, you could be stuck with a “negative equity” situation.
- Could You Handle a Rise in Interest Rates? Even modest rate increases can add up to a significant jump in your monthly payments if your balance is large.
- Do You Already Have Unsecured Debt? If you have credit card or other high-interest balances, adding a HELOC may only help if you commit to reducing overall spending and avoid piling up fresh debt.
Before applying for a new HELOC, stress test your finances over and above what the bank will do. Consider alternatives. If you’re carrying a lot of high-interest debt and already struggle with monthly bills, you might look at consumer proposals, credit counselling, or even a more detailed budgeting strategy to tackle the root cause of your debt challenges. These options can be safer—and sometimes cheaper—than turning all of your unsecured balances into one big secured debt.
Using a HELOC to Refinance Existing Debt
One common reason people open a HELOC is to refinance or consolidate existing high-interest loans (like credit cards). This approach can work under the right circumstances:
Pros
- Saves on Interest: Moving debt from 19–29% credit cards to a lower HELOC rate can reduce how much you pay in interest each month.
- Simplifies Payments: You have just one monthly payment rather than multiple bills.
Cons & Common Pitfalls
- Risk of “Double-Dipping”: If you don’t reduce your credit card limits or cut up your cards, it’s easy to start charging again. That means you could end up with a HELOC plus new credit card balances.
- Converting Unsecured Debt to Secured Debt: You’re putting your home on the line. If something goes wrong, like a job loss or unexpected bills, you could face foreclosure.
- Increasing Total Secured Debt: If you already have a sizable mortgage, you’re adding a second layer of risk tied to your property. High ratio mortgages can be a cause of insolvency if you can’t afford your mortgage payments.
Ultimately, if debt consolidation is your goal, make sure you also change the spending habits that got you into high balances in the first place. Otherwise, refinancing is just a bandage solution, and you could end up with even more debt over time.
A HELOC can be a useful tool for homeowners looking to lower interest costs or pay for necessary expenses. But it doesn’t solve underlying debt challenges on its own. If you’re worried consolidating unsecured debt with a HELOC might put your home at risk, or if you’ve already tried debt consolidation and still feel overwhelmed, talk to a Licensed Insolvency Trustee about your options.
At Hoyes, Michalos, we help you make a clear plan to restructure your debt. If you need help, contact us today for a free, no-obligation consultation.
