Should I use a HELOC to pay down debt?

As you pay down your mortgage, the equity tied in your home can be an appealing asset to manage financial stress. A Home Equity Line of Credit (HELOC) lets you use the equity in your home to cover large expenses or pay off debt, but is it worth the risk?

We’ve answered the most common questions about HELOCs and debt so you can make an informed decision.

What’s a HELOC?

A HELOC is a revolving line of credit, which means you don’t have to borrow it all at once. Instead, you can withdraw some of the money, wait, and withdraw again up to a maximum approved amount. You have to pay interest on the amount borrowed, not the total approved amount, giving you more control over monthly payments.

Unlike other lines of credit, like a personal or student line of credit, a HELOC is a secured debt attached to your home. This means you can be approved for a higher borrowing amount, up to 65% of your home’s market value, but if you fail to make payments your house could be leveraged as collateral by your lender to cover your debt.

What’s the difference between a HELOC and Home Equity Loan?

These terms sound similar but a Home Equity Loan, also known as a second mortgage, has different terms and risks than a HELOC. We’ve broken down the key differences below:

Should I use a HELOC or consolidation loan to pay off debt?

Not everyone owns a home, making a consolidation or personal loan the only option. Even for homeowners, it can be frightening to put your home up as collateral.

Both HELOCs and consolidation loans have lower interest rates than credit cards. Unlike HELOCs, consolidation loans have a set repayment schedule that can be difficult to manage if you are facing a gap in income like unemployment. Personal loans also tend to have lower borrowing limits than a HELOC, which could further limit your options.

It’s important to remember that a HELOC is still a secured debt. Unlike a personal loan or credit cards, a HELOC is connected to an asset and if you fail to maintain payments your lender could claim your home as collateral.

Whatever debt consolidation option you choose, it’s important to stay out of debt in the future. Paid off credit cards and access to more money through a HELOC or personal loan can encourage negative spending habits. When using a loan or line of credit to pay down debt, it’s important to stick to a budget and analyze your spending mindset so you can focus on debt repayment.

When making major financial decisions about debt, it’s important to consult a professional like a Licensed Insolvency Trustee (LIT).

What if I can’t pay off my HELOC?

If you fail to pay your HELOC, your lender could foreclose on your home to cover the debt. However, if you still have a mortgage on your house, that'll have to be paid first. HELOC lenders are less likely to pursue foreclosure if you have low equity in your home.

This doesn’t mean HELOC lenders won’t pursue you for the money you owe. Instead of going after your home, HELOC lenders can take legal action to garnish your wages or bank accounts, and even claim other assets, like vehicles, to repay your debt.

Like any debt, it is important to stay on top of HELOC payments, but this isn’t always possible. If you're unable to pay your HELOC or other debts, it might be time to talk with a LIT about the right debt solution for you.

Can I file for bankruptcy if I own a home?

One of the requirements for filing bankruptcy is being unable to reasonably pay off your debts. Homeowners with high equity in their homes may not meet this requirement since they could potentially get a HELOC to repay their debt. It should be noted that not everyone is able to access the equity in their homes because they may not have the monthly cash flow to support the interest payments

If you’re unable to reasonably repay your debt and you own a home, a percentage of your home equity is protected in bankruptcy. Each province has their own asset exemptions, so be sure to review the laws for your province. If your equity fits within your province’s exemptions and you can continue making mortgage payments in addition to your bankruptcy responsibilities, you should be able to keep your home. However, bankruptcy is not the only option for homeowners seeking debt relief.

More homeowners are turning to consumer proposals which allow you to settle your debt while protecting assets like your home and car. To find out if this is the right option for you, book a free consultation with one of our debt solutions professionals and start your journey to debt freedom!