Buying a new home is an exciting but often stressful experience. The variety of financing options now offered by lenders is overwhelming.
One of the most popular options is a home equity line of credit. With interest rates typically lower than other forms of credit, this line of credit can help you reach your financial goals. However, there are several factors to consider when deciding if this product is right for you.
Banks market home equity lines of credit under different names, which might make it challenging to recognize when you are being offered one. They are commonly combined with a regular term mortgage in the form of a “re-advanceable mortgage.”
When combined this way, the credit limit on your home equity line of credit will often increase automatically as you pay down the principal on your mortgage. A re-advanceable mortgage may also tie together other credit and banking products —such as personal loans, credit cards, and car loans — under a single credit limit.
Benefits of bundling these products together include convenience and lower interest rates. But the downsides include fees and restrictions if you want to switch to another lender, and variable interest rates that could increase on short notice. Your financial institution also has the right to demand that you pay the full amount owing at any time.
When deciding if this lending product is right for you, remember that your home is likely your biggest investment. You should beware of over borrowing against its equity, especially if you’re counting on it to fund your retirement.
“Most lenders allow you to make interest-only payments on your home equity line of credit, making it easier to delay repaying the principal balance,” explains Lucie Tedesco, commissioner of the Financial Consumer Agency of Canada. “Continually borrowing against your home’s equity without repaying the principal can jeopardize your long-term financial security. For instance, in the event of a housing market correction, you might owe more than what your home is worth.”
Ask yourself if a low-interest rate and easy access to credit may encourage you to spend more than you can afford to pay back. You could find yourself in a debt spiral, using additional home equity just to stay current on your mortgage. This could make you more vulnerable to unforeseeable events, like job loss, illness or an interest rate hike.
Consider creating your own plan to pay down the principal amount borrowed over a fixed period. Aim to pay more than the minimum payment or interest every month. With a home equity line of credit, there is usually no penalty to pay back as much as you can at any time.