Is a Home Equity Line of Credit right for you?

BY SCOTT BOURKE

A Home Equity Line of Credit (HELOC) can be a great tool for a person looking at investing, flipping homes or just to be used as an open mortgage. But on the other hand, a HELOC can be a very dangerous mortgage. Let’s look at some of the HELOC’s features.

A HELOC is fully open so it can be paid off with very little to no penalty. Some people use this as an advantage if they purchased a new home but currently have a home for sale that has not sold. Adding a HELOC to the purchased property makes it easy for a lump sum payment when the listed home sells.

A HELOC is re-advancable. A HELOC will work just like a credit card. As you pay the amount owing down, you have access to the funds again. This is one of those advantages that can be both a positive and a negative. On the positive side, if you are looking at purchasing a home to renovate and sell, you would only need to apply for the HELOC once. If you add this to your current home, you can use the funds to purchase a home and renovate it. When you sell the home again, pay off the HELOC and you are back to square one for the next one. On the negative side, depending on how you are with money this could get you into a lot of trouble. If you had $20,000 to $30,000 sitting available to you and you don’t think you could walk past that quad or boat that is for sale, this is NOT the product for you. Toys are fun, but is borrowing equity against your home the right way to get it?

Most HELOC’s have a minimum interest only payment. Again this is another good/bad benefit. If you look at our first scenario with the person that bought a new home but is still carrying his old home until it sells, an interest-only payment is a good thing. Their intention is to put a lump sum against the home and, with possibly carrying two mortgages paying interest only on one could make it easier until it sells. On the negative side, I have seen too many people adjust their lifestyle to the interest-only payment and only make the interest payments. In doing this, you just make a mortgage a lifetime mortgage. If all you are doing is paying interest, obviously your principle is staying the same. In five years time you still owe the same amount. Depending on the lender you are with, some will only let you go interest-only for a certain period of time, before it needs to be locked in. This could really get you in trouble when your payment turns into a principle and interest payment and it doubles.

HELOC’s float on a variable rate. Most rates on a HELOC are going to be around prime +.50% to prime +1%. With prime today at 3%, this could put you at 4%. Most economists agree that the prime rate should stay steady until the spring of next year, but anything can happen. If you have a $250,000 HELOC a 1% rate increase will bring your payments from $833 (approximate) to $1,041 (approximate). That is more than $200 extra in just interest per month.

You can lock the rate on your HELOC. Most lenders will allow you to lock in a portion or the entire outstanding amount on your HELOC. If you have a balance of $250,000 and you want to lock in $200,000 and leave $50,000 floating on the HELOC, you can do that. You can lock this in for a one to 10-year fixed rate at any time. The thing to remember on this is you are NOT locking in the rate your HELOC is currently at. You would be locking into the fixed rate mortgage that your lender is offering at that time. With most banks, after your fixed term is finished, your mortgage goes back into the HELOC revolving portion.

Interest is compounded monthly, not semi-annually. The interest you are charged gets added to your mortgage on a monthly basis versus semi-monthly like the fixed rates. If you are planning on doing a large lump sum payment to the HELOC, this could work out alright. If you are looking to just carry this as a regular mortgage, this could work out to costing you more in interest charges.

These are just a few of the advantages/disadvantages to a HELOC. There are many rules when it comes to qualifying to obtain one. You must have an excellent credit history, strong income and in most cases at least 35% equity with still one hold out in Alberta needing only 20%.

Scott Bourke is a licensed mortgage broker in Red Deer with Dominion Lending Centres Regional Mortgage Group.

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