Have you ever thought about how you might pay for a costly emergency home repair or an unforeseen life event? There may come a time in your life when you might need to access large sums of cash quickly. Have you tried to borrow money recently? It's not quite so easy to do as it once was. Either you can't get it because your credit may be lacking due to temporary job loss or you have fallen behind on important bill payments or you don't qualify due to your “confirmable income” level not meeting lender minimum requirements - hands up self employed people and small business owners.
On the flip side side, does it make sense to borrow when money when you don’t need it? Are you planning for home renovations, investments or looking to bolster your small business but are not sure when you will need money? Why would you pay interest on a loan that you don’t need yet? A Home Equity Line of Credit (HELOC) is a great solution.
A HELOC is a secured revolving line of credit registered as a charge against your home. The revolving part means the borrowed amount can go up or down to a specific limit similar to a credit card. The fact that it’s secured by your home means there is a valuable asset behind the loan to give the lender additional safety of repayment. This, in turn, provides you much lower interest rates than traditional loans since a real piece of property is the best collateral available.
Government regulations stipulate that a HELOC cannot exceed 65% of the value of your home, unless in second position (a debt secured after your mortgage), in which case you can borrow up to 80% of the value of the property and qualifying must be done using the 5 year posted rate with a 25 year amortization. Payments can be as low as interest only but but any spikes in interest rates can throw off the most dedicated budgeters!
For example, you purchase a home for $500,000, make an $100,000 down payment and your mortgage balance owing is $400,000. The maximum you’d be allowed to finance is based on the value of your property, $500,000 with your HELOC is $325,000 ($500,000 x 65%). The remaining $75,000 ($400,000 - $325,000) would need to be financed with a fixed term mortgage.
Keep in mind, the interest rate on a HELOC is based on the lenders prime rate and will fluctuate as the prime rate goes up or down. The interest is compounded monthly instead of semi-annually as most mortgage payments are calculated.
In the majority of cases, HELOCs are done as refinances at renewal time. As you pay down the mortgage on your property and the value of the home increases, equity is created. This is typically when the equity is accessed because it now exists. Payments are usually monthly and are "Interest Only".
Watch this video from the Government of Canada that cleverly explains a HELOC.
If used responsibly and with a sound strategy, a HELOC can have many advantages. Purchasing investments with a HELOC creates a tax deduction for interest paid. Renovating your home with a HELOC allows you to draw from it when you need it, only paying interest on the money used. Your children’s education, buying a boat/car or putting a down payment on a vacation property can all be facilitated with a HELOC. A HELOC can be a great tool for investments, renovations and short term financing needs. Anything longer term, however, is often cheaper to choose a conventional mortgage with a variable rate. The difference in the lower interest rate outweighs the flexibility of the HELOC.
When buying a home, most people take a conventional mortgage with a fixed term and rate. The smart homeowner understands the power of a conventional mortgage combined with a HELOC and/or a stand alone HELOC and a mortgage. Understanding your needs together with a strong financial strategy can turn your largest debt into your greatest asset! Let's chat about what might be best for your financial situation. It's your mortgage. It's your life.
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