Personal Investor: The right way to use a HELOC
The amount of money Canadians are borrowing against homes topped a whopping $222 billion this year. As borrowing rates rise, that figure should be a red flag for Canadians who have been using their homes as cash machines. But, for those with the discipline to keep the amounts small and the terms short, a home equity line of credit is a timeless treasure.
It’s rare that average folks can access money at such low rates. The rate on a HELOC is normally the prime lending rate, which is currently 3.2 per cent, plus one per cent. Banks will lend at 4.2 per cent because your house is collateral for the loan, and homes tend to hold most of their value.
Here are some good uses for HELOCs:
- Pay off high-interest debt: Interest on HELOCs is low because the debt is “secured” to equity in the home. Interest rates on “unsecured” debt are higher because the risk to the lender is higher. Rates on consumer loans can hit double digits, and on credit cards they can be as high as thirty per cent. By borrowing against your home at 4.2 per cent to pay off higher-interest debt, much more of your payments will go toward lowering the principal amount borrowed, and less will go to the bank in interest. Compound interest is almost always the wave that drowns borrowers in debt.
- Home renovation/repair: Investing in your home normally increases its value. When you borrow against the house for renovations or repairs, much of the money is being returned to the home as equity. Just be sure the renovations or repairs add to the value of your home.
- Supercharge your RRSP contribution: If you come up short for a registered retirement savings plan contribution come February, find on online RRSP refund calculator and figure out how much you will need to borrow to cover the refund. The more you contribute, the bigger the refund. When the refund comes in the spring, muster all your self-control and use it to pay off the debt.
- Emergencies: The banks will always tell you to save at least three months worth of living costs in case an emergency. That’s not only unrealistic, but a dumb way to store your cash as the bank makes interest on it. If your debt is under control, there’s no reason you can’t rely on your HELOC for a low interest loan when the car breaks down.