The Pros, Cons and Facts of Home Equity Lines of Credit (HELOCs)

With recent mortgage rule changes announced, Home Equity Lines of Credit have once again been thrust into the limelight.  Assuming much of the blame for the U.S. housing crisis, many people incorrectly believe that HELOCs are simply a bad thing.....It involves using the equity in your home as security for a low-interest line of credit.

Below is a great article published in the Globe and Mail on January 19th, 2011 that provides a great overview of a borrowing strategy that can work if used correctly.

"Borrowing is bad – we all get that.

Now, can we adults in the room have a conversation about debt? We’re the people who recognize that well-managed borrowing is part of everyday life, and thus have set up a home equity line of credit.

Home equity credit lines are the smartest, cheapest way to borrow money, and you should definitely have one in your back pocket if you have the discipline to manage it.

Some people don’t, and so the federal government included home equity credit lines in the campaign against household debt growth announced earlier this week. The Bank of Canada has also expressed concerns about the role of these loans in propelling debt to alarming levels, and so has Peter Aceto, chief executive officer at online bank ING Direct.

Let’s get something out of the way right up front. ING will introduce a new home equity line of credit product at some point this year. No, Mr. Aceto is not a hypocrite. He’s a realist on the matter of Canadians borrowing too much and his views are worth hearing if you have a home equity credit line yourself.
“I don’t think there’s anything sick, wrong or dirty with the invention of the home equity line of credit,” Mr. Aceto said in a conversation he initiated to get his concerns about national debt levels on the record.

His take on when to use a home equity credit line? “If you have a home and you want to use some of your equity so you can do renovations, or so you can pay down more expensive debt. If you’re doing the responsible thing.”
Growth in credit line usage suggests people aren’t that discriminating. According to the Bank of Canada, the volume of home equity lines of credit and loans has risen by as much as 170 per cent in the past decade, almost twice as fast as mortgage debt.

Why They're Popular
Home equity credit lines are popular because they allow the average person to borrow at the lowest possible rate because their house is used as security. These credit lines used to be available at the prime rate, currently 3 per cent, but since the financial crisis the banks have been padding their profits by charging a markup of half to a full percentage point.

If you have credit card debt, probably pegged at something close to 19 per cent, it’s beyond smart to pay off the balance with a home equity line of credit to take advantage of the much lower rate. In fact, it’s almost essential.

A case can also be made for using credit lines to build or protect personal wealth. An example would be to redo your worn-out kitchen or invest in stocks, funds or property.

Credit lines can also be useful for bridging a short period between the purchase of something and the arrival of money to pay for it. Where they’re a menace is when people fall into the habit of what Mr. Aceto calls “using your home as an ATM machine.” Can’t quite afford something you want right now? You can buy it using your home equity credit line and then pat yourself on the back for not being a sucker paying credit card interest.

The ATM Syndrome
It’s ATM-style borrowing that Ottawa has targeted through the largely symbolic decision to stop offering government-backed insurance to banks for home equity credit lines sold to clients.

There isn’t a lot of this type of insuring going on, especially at the big banks. So while there may be instances of lenders charging more to clients who set up new home equity credit lines or requiring better credit scores from applicants, the status quo should rule in many cases. Example: Bank of Nova Scotia and Canadian Imperial Bank of Commerce said Wednesday there would be no changes to their home equity credit lines related to the government announcement.

Meanwhile, ING continues building a line of credit that could easily makes it debut just as interest rates are starting a sustained move higher. Mr. Aceto said ING plans to be cautious about who gets a credit line, a reflection of its belief that banks must help clients borrow intelligently.

“Banks have a role to play in being responsible and in making sure customers understand the choices they’re making,” he said. “And even if [customers] do understand their choice and they want to make a mistake, we have an obligation to say, ‘No, I don’t really think that’s the right thing to do.’ ”

Some supervision by banks and governments is fine, but adults look after their own debt levels. Those non-stop warnings that debt is bad? They’re for the financial children out there.

The HELOC option

Facts on home equity lines of credit (HELOCs), as supplied by Vancouver-based mortgage planner Robert McLister:

What's the maximum you can borrow?
80 per cent of your home equity.
How much of your home do you need to own to qualify?
The minimum is 20 per cent.
What are the rates?
“The average is probably prime plus 0.75 [of a percentage point], but you can find at least six or seven lenders to do it at prime plus 0.5.”
How easy is it to qualify for a HELOC?
“It is notably tougher to get a HELOC than a regular mortgage.”
What are the setup fees?
“Generally it's about $250 for an appraisal plus $500-$800 for legal fees and disbursements. In some cases, the appraisal fee is covered by the broker or lender.”
What are the rules for monthly payments?
“Interest only, or interest plus principal like a regular mortgage payment, or you can pay a specific payment. The interest is the least you can pay.”
What if I fall behind on payments?
“After 90 days, things get hairy for the homeowner. But if you miss a payment, they'll call you up within two weeks.” "