Wednesday WTF: August 2, 2017
Home Equity Lines of Credit (HELOC’s)
Welcome back to Wednesday WTF my weekly rant about things that waste your money. This being debt week at Budget Boss we have literally dozens of topics that waste your money. Debt, in general, is a complete waste of money so who shall be my victim today? In this post, I will speak to Home Equity Lines of Credit and how they are wasteful and even dangerous. I spoke about the importance of an emergency fund in yesterday’s post. One of the reasons I gave for its importance was to protect your investments, including your home. Attaching a line of credit to your home equity is directly opposed to my post yesterday. The purpose of your home equity is to build investment value and stability. While HELOC’s have the promise of saving you money, they often fall short. There are several reasons why I would never recommend a Home Equity Line of Credit and in this post, I will go over a few of them.
They are not stable
Interest rates are ever changing and having an HELOC is similar to having an adjustable-rate mortgage. What that means is that your monthly payment can change anytime. Depending on the current rates this change can be significant. This can be a serious problem for those with tight budgets. People who need HELOC’s often have tight budgets and utilized the credit to consolidate debt. Getting out of debt requires a fixed budget that has stability. HELOC’s do not provide this and that can be costly to some. You also run the risk of borrowing much more than you anticipated due to rising interest costs. In a low-interest environment, you can predict a low cost to borrow. This changes once interest rates rise. In order to negate this possibility, you would have to lock in your HELOC at a fixed rate, similar to a fixed rate mortgage. These fixed-rate HELOC’s do come with a higher interest rate and that may reduce the appeal of the line of credit. For those looking for safety and stability, the HELOC is not the way to go. They require patience, discipline and sometimes an iron stomach.
Interest Only Payments are not good!
I remember when I used to have crippling OSAP debt. It felt like that I would never get that paid off. The reason I felt that way was because the repayment schedule I had chosen was ridicules. I wasn’t making much money at the time so I made the absolute minimum payment, $100 a month. That amount wasn’t even enough to pay the interest let alone attack the principle. HELOC’S allow you to make interest only payments much like a standard line of credit. That system is a problem in two very important ways. 1) This repayment level prolongs the repayment schedule sometimes to the point where the reason for having the HELOC becomes lost. You obtained the credit for the lower rate and flexibility and instead you may get more than you bargained for. 2) This repayment schedule also promotes laziness and consumption. Sometimes we all need a little fire under our butts and interest only payments don’t provide that.
The last thing anyone needs is “easy access” to more credit
You don’t invite your friend with a drinking problem out to a bar. You don’t bring a gambling addict to a casino. You also shouldn’t have access to vast amounts of credit if you already can’t follow a strict budget. I speak a lot about building net worth which includes growing your assets and eliminating your debts. I look at HELOC’s as a tool that can be used for both good and bad. Much like credit cards, they can be helpful but the impulsive nature of us all is what gets us into trouble. Chances are if you want access to such a large amount of credit you aren’t following the simple rules of sound financial planning. If that is the case than potentially adding a larger amount of debt onto your already full plate should not be for you.
I say it a lot but it is completely true. Understanding money is more about understanding yourself than learning about money itself. How you handle money including your compulsions, phobias, and tendencies is paramount. This is why in my opinion a Home Equity Line of Credit is dangerous. Most people I have met cannot have such an enticing credit source without using it negatively. Let’s put it a little more simply: If you have all your bills paid every month, have a solid emergency fund, are funding your RRSP and TFSA than do you really need this extra source of credit? I have a few credit cards and a line of credit that is never maxed out and are paid off every month. That to me is more than enough credit for one man. For those who have a small business, it might make sense. The key is that having an HELOC requires discipline. Your home is more than likely your most valuable fixed asset, it shouldn’t be messed with ever. The goal should be to pay off your mortgage during the regular amortization period. Getting a Home Equity Line of Credit might get in the way of that so beware.
Thanks for reading my post today about Home Equity Lines of Credit. Debt Week continues tomorrow with Thursday Trim the Trash Time where I will be speaking about the popular/hated student loan. Have a great day friends!
“Be incredibly, ruthlessly selfish with your equity.” – Douglas Leone
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Joseph James Francis is a Financial Advisor. You can find him on various social media platforms and at www.budgetboss.ca.