What is a Home Equity Line of Credit (HELOC)?

A home equity line of credit, or HELOC, is a flexible way of accessing the equity you have in your house through a low-interest credit line.

Because they are secured by a valuable asset – your home, HELOCs typically offer some very appealing features such as low-interest rates, flexible repayment terms, and more.

Features of a HELOC

Low interest rate
Repayable at any time without penalty
Pay interest only on the funds used
Access larger amounts of funds than an unsecured line of credit
No fees to access or draw funds

Although HELOC’s offer some attractive features, like everything, there is a right and a wrong way to use the funds you receive. Here are some Do’s and Don’ts to keep in mind if you’re considering applying for a home equity line of credit.

Do’s and Don’ts

Don’t: Buy a Brand-New Car

Although you may think it makes sense to purchase a brand-new car using your low-interest HELOC, this is something to avoid.

The flexible repayment plan that comes with a HELOC means that, although your payments may be lower, it will likely end up taking longer for you to pay off the car, resulting in more interest paid overall.

A better option when purchasing a car is an auto loan. These loans are structured for this type of purchase, with finance terms better suited to the life expectancy of your vehicle.

Do: Pay Down High-Interest Debt

One of the biggest benefits to a home equity line of credit is the low interest rate, especially when compared to higher-interest debt like credit cards.

For many people, it may make sense to pay off high-interest debt using a HELOC, however, this transfer of debt does come with a warning.

If you’re going to pay off your credit card balance using a HELOC, it’s important to first ensure that you have good spending habits in place. If you don't, you risk racking the credit cards up again with unnecessary purchases, leaving yourself in a worse financial situation.

As an example, if you have $10,000 in credit card debt, you’ll pay $167 a month in interest at the average credit card interest rate of 20%. Compare that with about $33 at 3.00%, the average HELOC interest rate, and you’ll see how using your HELOC to pay down high-interest debt may be a smart move.

Don’t: Cover Daily Living Expenses

One of the worst mistakes you can make with a HELOC is using it to cover regular living expenses and to support a lifestyle of living beyond your means.

Unfortunately, this is a fairly common problem for Canadians and can be very a very tempting trap to fall into.

Spending more than you earn can be an easy way to quickly rack up your line of credit, leaving you with high monthly interest payments and making it near impossible to pay down the principal balance owing.

If you’re using borrowed funds to cover your daily living expenses, you're not putting the money to its best use.

Do: Keep your HELOC for Emergencies

A HELOC gives you access to a line of credit that can be used as needed, but just because it's there doesn't mean it needs to be spent.

A great way to use your home equity line of credit is to not use it at all. Instead, keep the balance available to help cover unexpected emergencies, such as medical expenses, home repairs, or medical expenses.

Ideally, you should be setting aside a percentage of your monthly income to build up an emergency fund, but in the meantime, a HELOC can act as a great substitute.

Don’t: Make Interest Only Payments

Making interest-only payments might appear to be an effective way to manage your HELOC debt, but in reality, you're doing nothing to lower your principal balance owing.

Consider this, if you borrow and spend $100,000 with a home equity line of credit and make interest-only payments of $250 per month, you will have paid $30,000 in interest after 10 years and your $100,000 balance owing will not have changed.

This can become particularly challenging if interest rates rise, making your monthly interest payments higher and more difficult to manage.