We got used to relying on our home equity line of credit (HELOC) to get through the pandemic when we both lost our jobs. Fortunately, our mortgage lender set it up for us a few years ago when we extended our house. However, although we do our best to stay on top of payments, we are very concerned about what will happen if interest rates go back up, as we owe a significant amount. What can we do? ~Andira
, home renovations, emergency financing, family assistance, and high-interest credit card payments where lucrative loyalty points encourage constant spending. Our use of and reliance on them has grown exponentially over the past decades of low variable interest rates, rising property values and new mortgage products.
However, our dependence on cheap and easy credit is coming to an end as we speak. The unusually aggressive hike in interest rates by the Bank of Canada a few weeks ago will likely be followed by another big hike of at least another 50 basis points, or even 1%. Anyone with a balance owing on a HELOC will feel the effects of these increases. And the bad news is that interest rate hikes are only expected to continue for the foreseeable future.
The impact of the Bank of Canada’s interest rate hikes on your monthly home equity line of credit payments will depend on how much you owe and how tight your household budget is. Here’s what to expect and what to do to protect yourself:
What effect do interest rate increases have on monthly payments?
When the Bank of Canada raises its overnight rate, it means that it is more expensive for large financial institutions to borrow the money they need to fund the loans and mortgages they make to their clients. Our banks, in turn, are raising their prime rate to account for their own higher borrowing costs.
The prime rate is what determines the variable interest rate associated with HELOCs and unsecured lines of credit. You can check your own up-to-date interest rate by logging into your online bank. Beyond the interest rate you are charged, there are also the terms and conditions of your payments. Some payments are fixed at interest only, while others are combined with a percentage of your balance owing.
Blended payments mean that part of each payment goes against the principal while the other part is applied to the interest. Unlike interest-only payments, blended payments pay off what you owe. However, when interest rates rise, the higher cost of borrowing makes it harder to pay what you owe.
Consider this example of an interest-only payment for a HELOC:
Balance owing: $150,000
Current prime rate 3.20%
Interest only payment at 1% above the current prime rate (4.20%): $525/month
Prime rate, if it increases by 2.5% to 5.7%
Interest only payment at 1% above prime rate (6.70%): $838/month
Difference: $313 per month
If paying $525 a month stretches your budget, an increase of more than $300 could stretch it to breaking point. Get help before you reach this point. Speak to your mortgage lender or non-profit credit counselor for advice and options.
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Take steps to end your addiction to your HELOC
When you’re constantly relying on your HELOC to make up any shortfall in your monthly budget, the only ways to break the cycle are to reduce household expenses, increase household income, do a combination of the two, or sell. your home and fully reimburse the HELOC. . Easier said than done, of course.
When it comes to cutting your expenses, be ruthless as you analyze where each member of your household can cut costs and expenses. If your children are enrolled in several types of classes or sports, encourage them to choose their favorite each season. Switch to cash purchases instead of credit to get a better idea of where you’re spending your money. Cancel or suspend all services that are not absolutely necessary. Reduce any remaining lifestyle expenses by at least 25% (or more, if possible).
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The same can be said when it comes to decisions about increasing household income. Think carefully about whether someone can earn more (like taking extra shifts or a second job), whether you’re getting all the government benefits you’re entitled to (make sure you file your taxes on time and claim all your credits), if anyone in your household has the potential to earn an income that they currently do not (such as teenagers who might work part-time to gain skills and pocket money), if you could monetize your hobby and if you have the opportunity to generate income with your home by renting storage space or taking a curb).
The best strategies for balancing your household budget typically include both increasing income and decreasing expenses, rather than an all-or-nothing approach to either. Keep in mind that your HELOC is tied to your home and is considered a second mortgage. If you’re having trouble with any of your mortgage/HELOC payments, chances are you’ll be faced with tough decisions about staying, selling, or being forced to move by your lender.
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The Basics of the Dangers of Relying on a HELOC
A HELOC can be a valuable financial tool. However, with great power comes great responsibility. Low interest rates, easy access to funds and flexible payment terms mean that, when used wisely, your HELOC can help you achieve your financial goals successfully. But when used without considering higher borrowing costs in the future, that same HELOC can cause untold hardship. Interest rate announcements by the Bank of Canada shouldn’t make or break your day, but they’re as close to having a crystal ball as it gets. Use your glimpse of the future wisely.
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Scott Hannah is president of the Credit Counseling Society, a non-profit organization. For more information on managing your money or debt, contact Scott by
or call 1-888-527-8999.
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