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Monday, July 28, 2014

HELOC – Great or Evil?

Posted by Tim Stobbs on March 8, 2012

I had an interesting request from a reader,  Jacq, in regards to wondering what I thought of Home Equity Lines of Credit (HELOC) since I have one.  Like many things in personal finance depending on your point of view people tend to consider HELOC as a great tool or an evil way to get sucked into debt forever.

So what the hell is a HELOC anyway?  While the process may vary at your bank, this is how mine is setup.  My mortgage is referred to a STEP (Scotia Total Equity Plan), which means I can use the existing equity in the plan to have either multiple mortgages or secured lines of credits.  So for example, I could have a fixed rate mortgage for part of my mortgage and another part as floating rate and then several different lines of credit.  The mixture can be anything I want as long as my total debt doesn’t exceed the total pre-approved STEP grand total, which in my case is about $150,000.  If I wanted I could pay for an appraisal on my property and crank that total up towards 90% of my houses value (if my memory is correct, the limit may be 85% now).

Right now I have only one line of credit (LOC) right now of $12,000 and a mortgage of around $35,000, that means I could request a second line of credit of $100,000 with a call to the bank and signing a little paperwork.  Somewhat ironically I have been considering doing that very thing. Why?  Because secured lines of credit tend to have cheap interest rates associated with them, often you can get a rate just above the bank’s prime interest rate.  This then would allow me to selectively pick off investments as opportunity arise regardless if I don’t have the cash saved yet.  Then I can just pay back the LOC over a longer period of time.

Traditionally this is exactly what I use my LOC for, as my current balance on it came about from me dumping some cash into our TFSA in order to pick up some investments.  After all sometimes a good company has a crappy amount of press that results in a abnormally low share price and therefore high yield.  I don’t really do that all that often, but it does come up at times.  For example, I do believe I picked up some Riocan a while back when it was yielding almost 10%.

I will point out if you have a separate LOC which you only use to invest in a taxable account it is possible to write off that interest cost on your taxes.  I usually don’t bother with this as I only borrow small amounts for short time frames.  So yes, a HELOC can be a great way to grow an investment portfolio if you are short on cash and the market just tanked.

Yet HELOC can also be evil.  Since a bank doesn’t care what you borrow the money for, it is possible to abuse this tool.  After all, you can renovate your kitchen right now and then just pay it back later with a LOC.  In some regards it can function as a low interest credit card since your repayment options can be set as low as interest only payments.  So in reality I could put in my wife’s beloved cork floor in our kitchen next week and slap the entire cost on our HELOC, I don’t have to wait for us to pay off the mortgage first.  Yet I’m choosing to wait.

Or another good example is I know a couple that is retired and building a new cottage.  They plant to use a HELOC to even out their costs over a number of years to keep their income taxes lower than taking all the money out of their RRSP in a single year.  They have the money set aside already for the project, they are just using a HELOC as a tax planning tool.

So like all good tools, like a knife, a HELOC can be useful to make supper or you can cut yourself fairly badly with one and leak good money all over the place in interest costs.  I tend to classify HELOC as similar to credit cards, if you can’t resist using you card to buy stuff and you have to cut up your  card or keep it frozen in a block of ice in the freezer then you shouldn’t have a HELOC.  Yet if you are responsible with your debts you can use them to make yourself a little more flexible, I just suggest having a plan in place on how you will use it first.

So do you have a line of credit? What do you use your LOC for?

Comments

20 Responses to “HELOC – Great or Evil?”
  1. Marianne says:

    We have a ManulifeOne account that I don’t believe is technically considered a HELOC but is quite similar. I reviewed it on my blog. http://preservingpennies.com/manulife-one-review/ While we have loved the freedom it provides, it requires a lot of discipline and I would not recommend this type of account/mortgage for most people. It would be a disaster for anyone who is used to living paycheque to paycheque. Many see this account as a way to improve their lifestyle but thinking like that will not end well. When we opened our account the advisor said, ‘The most important thing with this account is that if you drive a [cheap car] today you still have to drive a [cheap car] tomorrow. If you go out and buy a BMW this account will not work for you.’ Exactly.

  2. Poor Student says:

    I have a $10,000 student line of credit and can reapply for an additional $10,000 every year that I am in school. I haven’t touched it yet but I keep it and plan to increase it for just as you said, attractive investment opportunities.

    Anybody reading your blog should have the discipline to handle holding a LOC and be able to know the difference between good and bad ways to use it. I may never use mine, but I like having it to know that I will not have to sell my current investments if a stock price blows me away.

  3. gcai says:

    Your comparison of a HELOC to a knife is excellent and totally accurate. If you can not handle credit stay away from the HELOC.

    Yes I have one used solely for investing – currently returning a steady net 5.5%, actually a bit more since the interest is tax deductible – very happy with that.

    For anyone setting up a HELOC do not be passive and accept what the bank offers as to interest rate – bank said it wanted prime + 1.0 – I said I’d pay prime + .25 – they said DONE! (I should have said Prime darn!)

  4. Paul N says:

    I agree with Marianne, if you don’t have self discipline then don’t touch one.
    If you do then it becomes a powerfull tool for you. If you have a large downpayment for a house you can use this product as a mortgage with no restrictions, and at a lower rate as it’s secured against your equity in your house. You can set up automatic payments. If you are paid with bonuses or get profit sharing you can simply pay off big chunks of your mortgage at any time without penalty.

    Everytime you do that you reduce your principle thus reducing the interest you pay. I was able to purchase two homes (stepping up to a bigger home) in this fashion and paying both of them off in under 10 years. The amount you save over the term of conventional mortgages in interest payments is huge. This done on one income with only an average salary and by no means going “without” anything to do this.

  5. Sheryl says:

    I have a regular Line of Credit that I use as an emergency fund.
    Once i get some debt cleared and am in a better position for investing, I’ll probably go to a HELOC and use it for investments if a good opportunity comes up and I don’t have cash on hand for it.

  6. Bill says:

    I also have a STEP plan and quite like it. I have 2 separate HELOC’s – one for my Smith Maneuver and one for true emergencies (furnace; roof, etc. – never used). As with most financial matters, discipline is key; I am very careful (almost too careful!) to make sure I have good tracking of the interest expense, dividends received and mortgage payments on my one HELOC. But I am only yielding about 4.75% right now :-(

    One thing that annoys me (maybe it is Scotia, maybe not) is that they seem really, really “slow” in re-advancing payments on my mortgage to my HELOC. It seems like they are always 4-6 behind. So I have a persistent amount that is always “available by calling”. Its just an irritant. I asked once and was told that the re-advancement is a manual entry that someone at the branch makes monthly … which seems just stupid. Sigh.

    Other than that they work well.

  7. Jim says:

    I believe I was told that if you run your own business and get a HELOC that your house is no longer safe from creditors if your business runs into trouble whereas with a normal mortgage the creditors can’t touch your house. Is this true? Or am I thinking of a different product?

  8. HELOC is credit, and since it’s secured, it’s cheaper than unsecured credit. That’s all. If you need credit then get the cheapest form you can which means HELOC.

    As far as I’m concerned, HELOC is good access to debt. Also, I don’t know, but I think that all assets are fair game in a personal bankruptcy, subject to some certain minimums, so using credit other than a HELOC does not protect your house, I think all it does is put the house first in line for remedy from the bank that issued the HELOC.

    Look at credit as a pool, and access debt in the cheapest way possible if you need it. Of course, consumer debt is not usually a very good idea so use neither a HELOC nor a credit card nor an unsecured LOC to finance dinner and a movie :)

  9. Canuckguy says:

    A recent article in MacLeans stated:

    “As of last year, Canadians had pulled roughly $220 billion from their houses in revolving home equity lines of credit, a per capita amount three times larger than the U.S. at its peak.Canadians are making more use of HELOC’s to withdraw equity from their houses than the Americans were doing on a per capital”

    Well folks, we all know how the American fairy tale ended. Beware.

  10. Jacq says:

    Thanks Tim! I have a regular $50k LOC that I haven’t touched since… well, since late 2008 / early 2009 when the stock market tanked and I knew I had a bonus + tax refund coming in to pay it off in a couple of months so it was basically a bridge loan. And very happy I did use it too, although I suppose it could have ended badly.

    I just checked and my rate on the LOC is 5%. I think I could get it down if I asked, but since I’m not using it, I haven’t checked into that.

    I’m banking with the RBC and from my discussions with the bank manager this fall (when I went in to get my 2% cash back M/C – yay!) I think they have some kind of HELOC type of offering now, but I’m not sure it’s exactly the same thing. I’ll explore it further when I’m up for renewal this fall. Thanks for the run-down on yours although I think I might be too risk averse to leverage investments even with cheap debt. Might need to man-up on that. (And I don’t class new flooring as an “investment” – maybe shares of Home Depot.) :-P

  11. Tim Stobbs says:

    @Jim,

    The only thing that protects your personal assets if you have a company is to incorporate. Other than that I think it doesn’t matter what kind of debt you have, your house is still fair game in a personal bankruptcy.

    @Alex,

    Thanks…I love the quote about dinner and a movie.

  12. Tim Stobbs says:

    @Jacq,

    Ah, now I understand your request a bit better. Good luck with the bank.

    Yes I agree flooring isn’t an investment unless perhaps you were going to sell your house in the next few months. Home Depot shares…mmm, now you have me thinking. :)

  13. Meghan says:

    I have a small LOC that I invested in dividend paying stocks. I plan to deduct the interest when I do my taxes next year (I just set it up). Because the loan is small, the amount of interest I will be able to deduct will not really make much of a difference, but I see this as a long term strategy.

    I agree that leveraged investments are very risky. I would feel less comfortable using a margin account, since I don’t understand how they work. An LOC is easier to wrap my head around. Also I wouldn’t leverage if I didn’t already have other investments–in my case a TFSA and RRSP containing a diversified portfolio of ETFs. So I felt comfortable taking on a bit of risk.

  14. Meghan: A margin account is just an account with a LOC attached. They will loan you a certain percentage of the value of your portfolio, like a HELOC will loan you a percentage of the value of your home. So if you have $10,000 in a margin account then you may have the ability to buy $15,000 in equities.

  15. TheOtherDave says:

    My financial advice to anyone who is at the “paying off their mortgage” stage of their FI journey (ie: all other higher interest debt is paid off), is to put every spare dollar they can scrape together down against the principal of their mortgage, get a HELOC and do not bother setting money aside for things like emergency savings, vacation savings, new-used car savings, general home maintenance renovation savings, savings to buy TFSA’s RRSP’s, etc… when these “PLANNED or EMERGENCY” expenses arise simply pull money from the HELOC and pay it back as quickly as you can and then go back to dumping cash against the mortgage. I know too many people who have a well planned out budget but say they can only afford to put down an extra 100-200 a month against the mortgage principal however they are squirreling away $100′s a month in all these other savings accounts where they make little to no interest when that money could be put against the mortgage that is likely at an interest rate 2-3 times the rate of the savings accounts. What I often recommend it that people prioritize and set goals and say “when my mortgage principal is down to $XXX,XXX.00 then we will spend the money on the car or vacation or reno”. People typically embrace this challenge and work even harder to get it paid down faster… And when the time comes might even put off the expense for a little longer till it’s really needed.

  16. Meghan says:

    Thanks Alex! Although I’ve heard that if your stocks drop in value in your margin account, than you may be required to sell off the stocks in order to pay back the loan. To me this seems too risky because then you are forced to sell low. That’s why I thought the LOC would be a better bet.

  17. Meghan: Yes. If the value of the stocks drop below the margin threshold then you would be required to either add cash or sell stock in the account until it came back to the right level. But if you have cash around (like the LOC) then it is easy to just do a cash transfer. I margin interest rates are usually better than unsecured LOC, and you can very easily tax deduct them because it is so obvious that they are for investment.

  18. Jacq says:

    Thanks for the ideas Other Dave. I’ve got funds in an
    “emergency” account earning 1% but the truth is I haven’t touched it in YEARS so it seems kind of pointless. I like your plan. But I also worry that I might be the type that puts off the expense – like until the mortgage is paid off entirely. ;-)

  19. Dani says:

    We have only a few months left before our mortgage is completely paid off. We are considering a HELOC, as the idea of buying a vacation property is enticing. Does it make sense to do this, or should we just save the down payment and get a traditional mortgage on the second property? What would be the advantage of NOT getting the HELOC?

  20. TheOtherDave says:

    @Dani: I would say that it would be better to put the mortgage on the vacation property. Especially if you are able to write off the interest and other expenses as a vacation rental and / or investment holding (not sure what kind of vacation property you are thinking of?)

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