If you are a homeowner and have equity built up in your home, it may seem like a good idea on the surface to tap into a home equity line of credit to cover expenses and other debts. But before you make that move, there are a number of things to consider.
“Although technically, equity that you have built up in your home is “savings”, there are a lot of points to consider before you draw down on that equity to cover expenses. With a home equity line of credit, you are essentially borrowing against your home. In some cases, this can be a smart move as part of your overall financial strategy. In some cases, borrowing against your home can increase instability in an already fragile financial position,” says Jeff Schwartz, executive director, Consolidated Credit Canada.
What are you using your home equity for?
First and foremost, much like with available credit, it’s not “free money”. Any debt taken out has to be repaid. That said, what is it that you intend to use your home equity line of credit for?
“There is good debt and there is bad debt. It is important to distinguish between the two. Typically, good debt is a debt that will help you increase your wealth and is a specific step in a financial strategy. Also, you need to comfortably be able to make the payments and have a timeline in mind for repayment. Bad debt is debt that is taken on, either to spend beyond your means or to cover expenses when you fall short in your household budget,” says Schwartz.
Let’s look at some of the potential uses for your home equity line of credit
One popular use for a home equity line of credit is for home renovations. This falls under the “good debt” category because typically home renovations will boost your home’s value, which will increase your equity as well. Before you draw on your line of credit, establish a plan and a budget for your renovations. It’s only “good debt” as long as you spend within your means.
It is possible to use your home equity line of credit to consolidate debt, but that may not necessarily be the best plan to pay down your debt. The reason is that you are securing your debt with your home. You may be lured by a lower interest rate, but do all the math, because there are other things to consider.
Why do you have all of these unsecured debts? Is it because you’ve been dipping into credit in the past because you can’t make ends meet? Taking equity out of your home is going to put you further into debt.
Another solution may be to take out a debt consolidation installment loan. The interest rates will be higher, but you’ll pay down your cards more quickly, have more cash flow to cover expenses and leave the asset you’ve got in your home untouched.
Boost your income or savings
Some people look to their homeowner’s line of credit to boost their income in retirement or intend to rely on it for their emergency fund. To use credit, whatever it is, in lieu of cash savings, isn’t a good idea.
You are far better off to devote part of your household budget towards savings: in RRSPs for your retirement and cash savings for your emergency fund. You’ll have the same cash flow, but you won’t be responsible for repayment down the road.
Need more advice? Our trained credit counsellors can help weigh your options, call (844)-402-3073 to receive the advice you need now. You can also complete our Free Debt Analysis online.