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?