For many Canadians, paying down their consumer debt can be a challenging task. With the average non-mortgage consumer debt rising to record levels over the past few years, individuals may be looking for effective strategies to help decrease their debt load and improve their overall financial well-being. One of those strategies is debt consolidation.
What is Debt Consolidation?
Debt consolidation is a method used to pay down multiple debts by paying them off using one larger loan. Ideally, the single, larger loan used to pay off the previous debts will have a lower interest rate so the total amount paid in interest over time will be less.
Options Available to Consolidate Debt:
- Personal loan or line of credit
- Transfer the balance to another credit card
- Home equity loan or line of credit
Using Your Home’s Equity to Consolidate Debts
For Canadian homeowners exploring debt consolidation, tapping into their home’s equity using a home equity line of credit (HELOC) can be a very appealing option. A HELOC is a secured line of credit that uses your home as collateral. Based on the value of your home in comparison to the amount that’s still owed on the property, you may be able to borrow the funds from a lender as a form of revolving credit. There are advantages and disadvantages to using a HELOC for debt consolidation which should be considered before deciding if it’s the right choice for you.
Advantages of Using a HELOC for Debt Consolidation
1. Lower Interest Rates |
1. Lower Interest RatesOne of the top benefits of using a HELOC to consolidate debt is the ability to access a lower interest rate compared to other loan types such as a personal line of credit or a balance transfer credit card. Because a HELOC is secured against your home, lenders can typically offer lower interest rates than they would on unsecured loans. HELOC interest rates are variable and are based on your lender’s prime rate plus a certain percentage. Interest rates play a large role in how much you’ll pay on your debt over time. Take a look at the chart below to compare the difference a lower interest rate will make in your monthly debt payments.
In one month, the interest savings amount to almost $100. When you consider compounding interest, this makes for considerable cost savings in the long run. |
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2. Simplify Your Finances |
2. Simplify Your FinancesAnother benefit of using a HELOC to consolidate your debt is the simplicity it can bring to your finances. Rather than making multiple payments at different times during the month for varying amounts, consolidating all your debts onto one loan means one payment once a month. |
Disadvantages of Using a HELOC for Debt Consolidation
While there are many beneficial reasons to use a HELOC for debt consolidation purposes, it may not be the right solution for every situation. Here are some potential drawbacks to consider before you make your decision.
1. Your Home is On the Line |
1. Your Home is On the LineIn the unfortunate circumstance that you’re unable to make the payments on your HELOC, your lender could foreclose your home. This is a very extreme scenario, but with your home as collateral, it is a possibility. |
2. Associated Costs of Obtaining a HELOC |
2. Associated Costs of Obtaining a HELOCSimilar to a mortgage, there are certain fees associated with getting a HELOC such as an appraisal fee, legal fees, and closing costs, to name a few. These fees can amount to a couple thousand dollars in total so be sure to factor in the cost if you’re thinking of getting a HELOC. |
3. Budgeting with a Variable Rate |
3. Budgeting with a Variable RateSince HELOCs in Canada use a variable interest rate, there is always the option that the interest rate will change. If you’ve only budgeted a certain amount towards your HELOC payment and the rate goes up, it may be challenging to keep up with the higher payment amounts. |
4. A Quick Fix vs. A Lasting Change |
4. A Quick Fix vs. A Lasting ChangeBecoming debt-free is often about changing habits or your approach to finances. While using a HELOC for debt consolidation may offer a solution to your current debt situation, re-evaluating the underlying reasons for your debt is equally important. By incorporating a budget with your debt consolidation efforts, you’ll be able to have a more positive financial future. |
Homeownership comes with its share of responsibilities and to-dos. MCAP is here to help you navigate through the different stages of owning a home. Take a look at our other blog articles for more tips, or contact us if you have questions.
