Dale Jackson

Personal Finance Columnist, Payback Time

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A nearly five per cent spike in interest rates in less than two years has Canadians backing away from their much-loved home equity lines of credit (HELOC). 

By last summer, the use of HELOCs had fallen 13 per cent since the Bank of Canada rate hiking cycle began in early 2022, according to MortgageLogic.news strategist Rob McLister. During that same period the average HELOC interest rate rose to 7.7 per cent from 2.95 per cent.

Some of the drop in HELOC use can be attributed to stricter lending requirements, but being able to tap into quick cash from the equity in your home can still come in handy for those with the ability and discipline to pay it back quickly. 

HOW A HELOC WORKS

A home equity line of credit allows homeowners to borrow against the equity in their homes whenever they want by simply transferring cash when they need it, and paying back as little as the monthly interest when they can.

Borrowing limits are generally up to 80 per cent of the home’s appraised value, minus any outstanding debt on the first mortgage.

HELOC rates are relatively low because the debt is secured by the equity in your home but like any other debt, interest on the borrowed money compounds. When rates are higher, like now, they compound much quicker. 

“Many monthly payments have almost tripled per $10,000 borrowed and delinquencies are rising,” says McLister.

A LIFELINE IN EMERGENCIES

Even with interest rates at a three-decade high, however, it’s good to always have a HELOC in the event of an emergency. It’s easy to access quick cash if your car breaks down or a family member suffers a health crisis that isn’t covered by insurance.

“HELOCs are a lifeline for tens of thousands of Canadians who have no other means of covering their bills amid high inflation, extreme housing costs and, in many cases, income loss,” McLister says.

Borrowing short-term money only when you need it is much more cost effective than money sitting idle in an emergency fund. That emergency fund can be better utilized by investing in a registered retirement savings plan (RRSP), a tax free savings account (TFSA), or paying down debt.     

DEBT CONSOLIDATION AND FINANCING

Because HELOCs provide the lowest rates for most Canadian borrowers, they can also be used to consolidate higher-interest, unsecured debt such as student and consumer loans and significantly lower overall payments.

In addition, they can come in handy for big purchases or to proceed with the purchase of a new home if the deal to sell the old one falls through. A HELOC can play a large part in bridge financing if closing dates don’t line up. 

LEVERAGE FOR INVESTING

A HELOC can also be used strategically as leverage for investing in low-risk ventures. RRSP contributions, for example, can be supercharged by calculating the refund before the March first deadline, borrowing the extra amount for a few months to add to the contribution, and paying it back when the refund comes in.

Investors with a higher tolerance for risk can borrow from their HELOCs when markets sell off or the economy recedes.    

“HELOCs are a recession shopping cart for well-qualified borrowers. They provide homeowners the capital needed to scoop up assets at fire sale prices if and when recession hits,” says McLister.

TIPS FOR GETTING THE BEST TERMS

The interest rate on a HELOC is usually tied to the prime lending rate at most banks and the difference can be negotiated. If the rate is variable, however, the principal will be sensitive to interest rate changes. In some cases, a lender will offer fixed-term home equity loans over various periods of time like a conventional mortgage, but HELOC rates remain susceptible to rising interest rates whether the principal grows or not.