A Home Equity Line of Credit (HELOC) is a type of second mortgage that can be used to pay off your debts, as well as cover other financial needs such as home renovations and vehicle repairs. While a typical second mortgage comes with a structured repayment plan, a home equity line of credit often only requires the interest charges to be paid each month. A licensed mortgage broker can help you find a HELOC provider with the lowest interest rates.

How it works

A HELOC is a line of credit that uses the value of your home as collateral. The interest rate charged on a HELOC is lower than that of an unsecured line of credit because it is secured to the value of your home. However, it is often slightly higher than the rate of your actual mortgage.

Although HELOCs come with interest rates that are lower than those of typical second mortgages, it can end up costing you more in the long run due to its open repayment structure. The fixed monthly payments on a second mortgage will ensure that its balance is decreasing each month until it is paid in full, usually within a one to five-year repayment term. With a HELOC on the other hand, because you are responsible for paying only the interest that was charged each month, you could end up making interest-only payments for years and years, and never actually see the balance go down.

For example, if you borrow $50,000 on your HELOC at a variable interest rate of approximately 5%, then you would be required to make payments of roughly $208.00 each month to cover the interest. Yet the $50,000 balance would always remain the same. Therefore, to reduce the $50,000 balance, you would need to take it upon yourself to pay the $208.00 monthly plus an additional amount to bring down the principle balance. For this reason, a HELOC may not be an ideal solution for getting out of debt if you prefer structured debt payments or lack the financial discipline required to make the higher-than-minimum payments needed to pay it off.

When to get a HELOC

As there are little to no fees associated with getting a HELOC, it can be ideal for paying off both small and large amounts of debt. A HELOC is a separate product from your mortgage, so it is a good alternative to refinancing if you are in the middle of your mortgage term and would incur financial penalties for breaking your mortgage early.

Ideally, the annual interest rate on your HELOC should still be much lower than the interest rates of the debts that you are paying off in order for it to be a useful debt repayment tool.

As the interest rate on a HELOC is variable, you will need to carefully calculate the amount needed to be paid each month in order to pay it off within a desired amount of time. The HELOC can be paid off at any time without any penalties. However, as the banks’ interest rates increase, so will the interest charges on your HELOC. If you carry the balance on your HELOC for too long, the interest rates may increase so much that even your required interest-only payments become unaffordable. Additionally, it can be expensive to refinance your mortgage at a later date if you ever decide to convert your HELOC balance into a mortgage to get a lower interest rate. Therefore, you should proceed with caution when deciding to use a HELOC for debt relief.

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