For many Canadians, paying off their mortgage faster and managing their debt more efficiently is a cornerstone of their financial strategy. From fewer monthly payments to less creditors to manage, and having a streamlined debt repayment strategy definitely makes life easier. To help pay off their mortgage faster, one strategy many borrowers explore is using a Home Equity Line of Credit, or a HELOC. Let’s talk about what a HELOC is, when you’d want to use one, and the pros and cons of using one to pay down or pay off your mortgage.
First things first, what is a Home Equity Line of Credit (HELOC)?
With a HELOC, you can use part of the equity you have in your home as collateral to borrow money. Like a credit card, this amount is revolving, meaning you can use the money, make payments, and draw down again without having to enter into a new contract. We discuss HELOCs in more detail in our blog post, What is a Home Equity Line of Credit?. If you’re not familiar with HELOCs, this is a great read to get the basics of the different types of HELOCs and their features.
The main features of a HELOC are:
- A variable interest rate, usually lower than unsecured loans
- Interest is only paid on borrowed amounts, not the full allowable limit
- Ongoing access to funds up to a set limit as you repay, like a credit card
Why would you use a HELOC to pay off a mortgage?
The housing market has boomed in recent years, with many cities and districts across BC and Vancouver Island in particular experiencing high appreciation in home values. If you purchased your home a few years ago, there’s a good chance your home is now worth more, meaning you have a potentially significant amount of equity to access and leverage.
Some homeowners use a HELOC to:
- Consolidate higher-interest debt, like credit cards and car payments
- Refinance their home at a lower rate (if their mortgage has a higher interest rate than the HELOC)
- Create more flexibility in repayment terms
The benefits of paying down a mortgage with a HELOC
For homeowners with the right financial situation and mindset, using a HELOC to pay down their mortgage has many benefits.
- Need Lower Payments: While HELOC rates are typically higher than fixed mortgage rates, the fact that you can make interest only payments rather than interest & principal as is the case with a conventional mortgage will usually result in lower payments. This can be quite helpful during difficult financial times where “cash flow” is paramount.
- Flexible repayment: Unlike a mortgage’s standard payout structure, homeowners can pay back HELOCs with as little as interest-only payments like they could with a credit card and or pay down even up to all of it. This isn’t the case with conventional mortgages, which typically allow anywhere from 10%-20% of the original mortgaged amount to be paid over and above the annual payments without incurring a penalty.
- Access to future funds: Once you’ve signed a contract for a HELOC, the funds are available to you to reuse once you’ve paid down the HELOC, again similar to a credit card. Whereas with a conventional mortgage you would need to requalify to borrow additional funds again.
The drawbacks of using a HELOC to pay down a mortgage
While HELOCs sound fantastic, they’re not a traditional mortgage payoff strategy and should be approached with caution. There are a few drawbacks to HELOCs, which mainly boil down to how disciplined you are with your money and your potential future mortgage moves.
- Variable interest rate risk: For homeowners who like the stability of a fixed interest rate, HELOCs like a conventional variable mortgage add a level of uncertainty due to their variable interest rate. As we’ve seen in recent years, interest rates can rise quickly, which could erase any short-term savings gained by using a HELOC versus the standard mortgage repayment structure.
- Discipline required: Since repayment terms are flexible, it can be tempting for homeowners to pay less, for example interest only, resulting in never paying off the outstanding principal: the “never-never” plan!
- Less financial flexibility when remortgaging or switching lenders: For many lenders, you may be required to pay off your HELOC in full when remortgaging your home or switching lenders as not all lenders offer a HELOC product.
What are the eligibility requirements for a HELOC in British Columbia?
Just like when qualifying for other financial products like mortgages and credit cards, lenders look at your financial situation when determining your eligibility for a HELOC. In particular, they look to see if you have at least 20% equity in your home, a strong credit score and history, and stable income and low debt ratios. These factors all ensure you have the cash flow to be able to pay the HELOC back in a timely manner. The amount you can borrow with a HELOC is up to a maximum of 65% of your home’s appraised value.
What are some alternatives to using a HELOC to pay down my mortgage?
HELOCs are not the only way to help fast-track your mortgage repayment strategy. The few other methods we recommend to clients typically include:
- Taking advantage of your lenders lump-sum pre-payment privileges, this will vary from lender to lender, so best to confirm with your lender directly
- Refinancing your mortgage ideally for a better rate and/or shorter amortization
- Using a blended mortgage, which combines your existing mortgage rate with a lender’s current rate, resulting in a new rate somewhere between the two, once again with the goal being to wind up with a lower one with a shorter amortization.
Apply for a Home Equity Line of Credit in BC
Think a HELOC is the way to go to pay off your mortgage? Let’s chat more about your options and find you some possible lenders! Contact us today for a free consultation with a mortgage expert at Auxilium. We’ll review your current financial situation, long-term goals, and financial risk aversion level to make sure a HELOC is the right move for you.