The concept behind a Home Equity Line of Credit (HELOC) is simple – leverage your home in return for a hefty line of credit to draw from.
However, it’s the underlying challenges associated with HELOC variable interest rates that makes a HELOC a tool best reserved for the thrifty and financially astute.
“You have to be very disciplined in that you’re going to be able to manage being your own banker from a borrowing perspective,” says Chris Kiskunas, regional mortgage sales manager at RBC.
The Risk of Rate Increases
It becomes a balancing act of sorts when it comes to the interest rate associated with a line of credit of this nature, especially when interest rates have no fixed value. For the past few years, rates have been historically low – but that can change, especially as Bank of Canada Governor Mark Carney warns of a moderation to stimulus measures on the not-so-distant horizon.
“When you have an interest rate of 3.5 per cent, you have to figure that the impact on a person’s cash flow is pretty manageable,” says Kiskunas. “Compared to if the rate were to go up to five or six per cent.”
A Per Cent Goes a Long Way
When we’re talking about loans of $1,000, a rate increase of three to four per cent is hardly an issue.
“When were talking about people leveraging the equity of their home, that HELOC may be $100,000 to $300,000,” says Kiskunas. “You can appreciate a point increase in the interest rate is going to become quite significant in terms of cash flow.”
Account for Depreciating Value
It’s not just varying interest rates that pose a challenge; property values can fall and long-term purchases like vehicles depreciate.
Kiskunas says a good point of advice for those with a HELOC is to use it as a vehicle for short-term purchases. “The inherent danger in credit lines is the availability,” she adds. “Use HELOCS for short-term purchases if you can pay them back from your cash flow.”
If you’re concerned with the impact of the varying interest rates, you can convert some of your HELOC on to a reducing vehicle such as a personal loan or mortgaging segment.
“You’re completely open for prepayment and payments in full,” Kiskunas adds.
Before signing on for a HELOC, it’s smart to seek professional advice from someone who understands the recent market changes, the impact of the changes the government has recently made, and how that will affect the interest rate over time in addition to your appetite for risk and financial history.
“To sit around the coffee table and discuss arbitrarily whether the HELOC is the right thing for you is a nice coffee conversation but you need sager advice then that,” adds Kiskunas.