For many Canadians, the idea of a Home Equity Line of Credit (a.k.a. A HELOC) is a foreign concept that contradicts the conventional way of thinking about your mortgage. With the way that the financial system in Canada works, particularly the fact that mortgage interest is not tax deductible to Canadians, many of us have been brought up with the idea of the standard 25-year mortgage, where you make your bi-weekly payments to pay off your home over the next twenty-five years. In fact, if you do make those payments biweekly, you can have it paid off in twenty-two years, saving yourself thousands of dollars. But what about other options that are out there? We know pretty clearly from the lenders’ balance sheets that the traditional mortgage products make them a lot of money. What about an option that makes more sense for you than those traditional mortgages? The answer may be a HELOC, which is different from a traditional mortgage. A Home Equity Line of Credit is a tool that allows you to utilize the equity in your home as a tool to build your wealth, as well as making it possible to pay off your home significantly faster than traditional mortgages. Why doesn’t everyone use these if they are so great? The reason lies in the system that we were brought up with and how embedded we are with the idea of what a mortgage is. HELOCs require someone who knows how they work to explain them to you. Once you, as a someone, wrap your head around them, you can see just how powerful a financial tool they can be. Let’s take a look at Home Equity Line of Credits and figure out how they may be a good fit for you.
In This Article:
- Meet a HELOC Pioneer….The Manulife One Account
- How to use a HELOC to Grow Your Wealth
- The Key to Why A HELOC Can Help You
- Why A HELOC Requires You to Plan and Stick to It
- Talk to The Experts
Meet a HELOC Pioneer….The Manulife One Account
When we talk about a ‘HELOC’, many people haven’t heard that term before, but if you bring up the Manulife One Account, that’s a different story. Back in the early 2000’s, Manulife brought this product to Canada and accompanied that launch with a large advertising push to help the launch. They advertised a way to calculate something called your ‘Manulife One number’, which was an online calculator that compared using a traditional mortgage and the Manulife One account and then showed you how much faster you could have your home paid off using the HELOC option. The simplest explanation for how this happens is that with a HELOC, every dollar that you have works for you for as long as you have it. So if you had a balance of $100,000 on the HELOC and your pay from work is $2,500, when that deposit happens, you now only have to pay interest on $97,500. The effect of a deposit into the account is instant and saves you money immediately because you are paying interest on a smaller outstanding loan balance. Compare this to a traditional mortgage, where your payment covers both interest and principal every time. Given the method of amortizing the interest that lenders use, early on in the life of your mortgage, the majority of your monthly payment is actually applied to interest, not principal. By having the amount of interest that you are being charged reduced, your cost of borrowing goes down, and you end up paying off your home much faster.
How to use a HELOC to Grow Your Wealth
One way that many Canadians want to diversify their investments is to purchase real estate. Investment properties are an excellent way to diversify your portfolio and can supply you with not only long-term capital growth but also cash flow in the short term. HELOCs can help you take advantage of opportunities to buy investment properties in a few ways.
- You can use the money from a Home Equity Line of Credit to provide the funds for the down payment on a property. Investment properties (when not owner-occupied) have slightly different rules than your principal residence when it comes to purchasing them. In particular, you must have a minimum down payment of 20%. Being able to use a HELOC as the source of this investment is quick and easy.
- If your HELOC allows you to create sub accounts, you may be able to make the interest you pay on the down payment funds that you borrowed tax-deductible. Money that you borrow for the purpose of earning income (like rental income) is often tax-deductible. Because you are borrowing from the HELOC to invest in real estate that will generate income for yourself, you may also get a nice tax deduction out of the deal. Being able to create subaccounts in your HELOC makes this more attainable because you can show that the money in that subaccount was used for the investment that makes the interest tax-deductible. If you mix that piece of borrowed money with other borrowed funds from non-investment use, none of it is tax-deductible. Talk to your accountant to make sure you can take advantage of all of the tax deductions possible if you are looking at this as a strategy.
- As a final note, Manulife One offers an investment property program. This means that you could have an investment property with a Manulife One account on it instead of a traditional mortgage. Why would you do this? Think of tax efficiency. The interest you pay on money borrowed to generate rental income is tax-deductible, while the interest you pay on your principal residence is not. So if you have a rental property where you have a Manulife One account on it, when the rental income is deposited into the account, you could turn around and transfer that money towards paying off your principal residence. This makes the most sense tax-wise because you are focusing on paying off your non-tax-deductible debt first. (As always, you should check with your accountant to make sure this idea fits with your plans).
The Key to Why A Home Equity Line of Credit Can Help You
Many Canadians face one major issue when it comes to their financial situation. The reality is that, for most people, if they own a home, the majority of their net worth is tied up as in accessible equity in that home. This means that even though your balance sheet may look great, your ability to access cash is limited, and with that limitation comes limits on how easy it is to take advantage of any financial opportunities that come your way. Think of this, if you have access to your home equity, perhaps you could do something like renovate your kitchen or bathroom, both of which are renovations that are proven ways to increase the value of your home. Or maybe you can use some money to finish your basement. In any of these examples, if you had a HELOC, you could take money out of the account to pay for a renovation that typically increases the value of your home more than the cost of the project (at least, that’s what watching ‘Love It or List It’ has taught me). Many years ago, clients who were planning a renovation on their home came to me and asked about taking out a mortgage on their mortgage-free home to allow them to finance the project. When reviewing the case, we decided that a HELOC made far more sense for one reason. If the project budget is $100,000 and we took out a mortgage for that amount, what happens when cost overruns happen, and all of a sudden, you need $125,000? The value of the home before the renovation was well over $500,000, so we were able to place a HELOC up to $325,000 on the property (65% of the value of the home). This allowed the homeowner the peace of mind knowing that, in the event the project cost more than they had originally planned, they were certain of their ability to fund it. It also provided the opportunity to pay off the loan much faster than a traditional mortgage, saving them money on interest costs as well. The bottom line is that having an account in place that allows you to access your home equity in terms of cash, as opposed to it being inaccessible, can make your financial life easier.
Why A HELOC Requires You to Plan and Stick to It
As with all credit products, HELOCs carry risk with them. It isn’t ‘free money’ that you have access to; increasing the balance on your HELOC account increases the amount of interest that you pay each month. Careful planning is required, and the homeowners need to be disciplined with their approach to credit to be good candidates for a HELOC in place of a mortgage. Things like variable interest rates and potential decreases in real estate values also need to be accounted for when you have this type of account because interest costs can increase when prevailing rates change, or the lender may be able to reduce the amount of credit available to you if the value of your property decreases. You need to make sure that you are making your payments and avoid getting trapped in a cycle of overborrowing to have the HELOC model work for you.
Talk to The Experts
The bottom line is that a HELOC is a great tool to leverage your income in a way that can make it so that you pay off your home faster and more efficiently than you could have with a traditional mortgage. But you need to make sure that you have a solid financial plan in place that combines with your Home Equity Line of Credit plan. Talking to a team of mortgage professionals and financial advisors who work together closely with you to build this type of plan is essential to making a Home Equity Line of Credit plan work. Talk to the team at Strata Mortgages and Strata Wealth & Risk Management (and as a bonus, speak to Strata Accounting to make sure that the tax planning works for you as well) today to see if a HELOC is a planning tool that can help you.
