Real estate prices continue to climb in the GTA and many homeowners now find themselves with a sizable amount of equity in their home or condo.
It can be tempting to tap some of that wealth. If you want to use the equity in your home you have two main choices, you can refinance or take out a Home Equity Line of Credit, or HELOC. They’re two very different products that homeowners should carefully consider.
What is a HELOC?
A HELOC is a line of credit or a revolving account. It allows you to borrow against your home equity. When you withdraw $100 from your HELOC you’re essentially decreasing your net worth by that amount immediately, as the money is not coming from savings but from the value in your home. Rates can vary, but HELOCs always come with a floating rate, usually prime plus 0.5 percentage points.
There are number of pros. A HELOC is a cheap source of readily available cash. It can be used for anything — paying off higher interest debt, buying a car, renovations, investing, education or emergencies. As well, since the payments are interest only, you never have to pay the principal down as you would in a mortgage. Also, unlike a mortgage you pay the balance off at any time without any penalty.
But there are some major disadvantages of a HELOC too. Since the interest rate is floating rates can go up, making the money you owe more expensive to manage. Temptation is high as HELOCs are easily accessed through an ATM. Consolidating debt is a good idea, but if you are using HELOC to do so, always have a plan to get that new lower interest loan paid off. You’re charged interest from the day you withdraw money from your HELOC; there’s no grace period like there is with credit card purchases.
What does it mean to refinance?
When you refinance your mortgage you are taking out a lump sum amount from the equity of your home. If you have equity you can refinance at your current rate, or if rates have come down you can refinance at a lower rate, and effectively lower your cost of borrowing at the same time. When you refinance you’re extending your mortgage, so the money is transferred to you as soon as you’re approved and the interest paid is on the entire loan. As it is with any mortgage, the borrower must make interest and principal payments on a schedule.
The bonus of refinancing is you often get a lower rate than what you would get with a HELOC, so your cost of borrowing is much less. With refinancing it also keeps you on a schedule so you are less likely to be tempted to take out more than you need.
The cons are the money is inflexible. Breaking the terms of your agreement in traditional refinancing are much harsher than if you closed or paid down your HELOC.
In both cases you can access up to 80 per cent of the equity in your home, minus any outstanding balance. Regardless of what you decide to do, remember this is equity you built up in your home over a long period of time. Once you’re approved remember you’re borrowing from yourself.
RUBINA AHMED-HAQ is the Finance Editor for HOMES Publishing. You can read her columns in Condo Life and Active Life. She’s also the finance expert on The Steven and Chris Show, regular contributor on CBC Radio, blogger at RateSupermarket.ca and has her own website AlwaysSaveMoney.ca.