Home equity loans are not much different than other loans. With a home equity loan, borrowers can use the loaned funds to cover whatever costs they want, whether that be a new car, a new wardrobe or a summer vacation. The funds are theirs to use as they please.
Although there are multiple uses to home equity loans, homeowners often use these funds to support major home renovations and improvement projects. In other words, they’re borrowing against their home to make it better. This strategy can come in handy if an individual intends to sell their home. First, they use the funds to increase the value of the property. Then, they recoup those funds through the profits from the sale.
In other cases, homeowners will take out home equity loans for the sole purpose of paying down their debts. Consider why homeowners who are struggling financially shouldn’t use these loans to manage their debts and how alternative solutions like consumer proposal services in Toronto can be a better option for debt relief.
What Is Home Equity?
First thing’s first: what is home equity? Home equity is the value of your property that you officially own. You’ve paid for it. If your original mortgage loan started at $700,000, but is now $300,000 after you’ve consistently made payments, you would have $400,000 in equity. Essentially, every time that you make a mortgage payment, you build more equity.
Homeowners can use this home equity to their advantage and access major borrowing opportunities by using the equity as collateral. They can either apply for a home equity loan or a home equity line of credit (HELOC).
What’s the Difference?
Home Equity Loan: A home equity loan is a secured loan that often comes with a fixed interest rate and is sometimes called a “second mortgage.” If you’re approved for a home equity loan, you will receive a lump sum of funds that you can access immediately. The repayment process will begin soon after you receive these funds.
Home Equity Line of Credit: A home equity line of credit is a secured line of credit that often comes with a variable interest rate. It’s a form of revolving credit, similar to a credit card. You can withdraw funds from the line of credit whenever you want (as long as it’s within your limit), and you can reuse the account as long as you pay down the balance and replenish the available credit.
The Risks of Home Equity Loans
Every loan comes with risks — and home equity loans are no exception. If you have enough home equity to take out a loan or HELOC, you should learn about the risks before you apply:
These borrowing options come with interest. While you may be capable of tackling the principal loan or withdrawal in a short period of time, you may have a harder time making repayments when they’ve accrued interest. The higher your interest rates, the faster your debts will grow or the more you will pay before the loan is paid back.
HELOCs can present more difficulties when it comes to interest because they have variable rates. This means that your interest rates can change while the line of credit is in use and impact the payments that you have to make. You will be at the whims of the market, which isn’t comforting if your finances can’t handle any sudden changes.
When you take out a secured loan, you’re using an asset as your collateral. The risk with these loans is that you could lose the asset when you default on your payments. So, if you can’t pay for your home equity loan or HELOC, you could lose your home. The lender could begin foreclosure and evict you from the premises.
Diving Deeper into Debt:
Finally, one of the biggest problems that comes with home equity loans and lines of credit is that they encourage you to go deeper into debt. These borrowing options tend to offer large sums, which could incite you to spend well beyond your means. You could end up with a balance that will take you a very long time to tackle — or worse, a balance that will become impossible for you to keep up with. It will be easy to stumble into financial trouble.
Alternative Options: Consumer Proposals
A consumer proposal is a legally binding agreement made between a debtor and their unsecured creditors. In a consumer proposal, the debtor agrees to repay a portion of their unsecured debts over a maximum of 5 years. After completing that portion, the unsecured debts to these creditors are considered paid in full. The applicant can remove that weight off their shoulders and get a fresh start when it comes to their finances.
If you’re struggling with debt, you can contact our debt professionals at David Sklar & Associates and book a free consultation. One of our licensed insolvency trustees will go over your finances to see whether a consumer proposal is the best choice for you and whether you meet the qualifications. If you check all of the boxes, they will get you started on the process!
The Advantages of Consumer Proposals VS Home Equity:
There are a lot of great reasons to file a consumer proposal. One of those reasons is that the process doesn’t affect your assets, including your home equity. There is no risk of losing your home because of this debt relief solution.
If you’re worried that signing onto a consumer proposal will affect your assets, you may be confusing it with personal bankruptcy. The personal bankruptcy process can involve the collection of your assets for the sake of debt repayment — although there are many asset exemptions in Ontario.
Consumer Proposals and Secured Credit:
Consumer proposals do not affect your assets because the process involves your unsecured creditors, not your secured creditors. Home equity loans, HELOCs and mortgage loans, on the other hand, are all forms of secured credit. The proposal will not involve these lenders, and it will not lower the payments for them. You will have to continue to make your scheduled payments to these creditors as normal.
A consumer proposal may not be able to reduce your secured debts, but it can at least make it easier to pay them down. By pausing interest and lowering the costs for your unsecured debts, you can put more time and money toward your secured debts.
If you’re wondering if the proposal payments will get in the way of your secured debt payments, rest assured that they shouldn’t. Our licensed insolvency trustees know that you could lose your asset if you default on payments for your home equity loan, HELOC or mortgage. They also know that you could nullify your consumer proposal after missing three months’ worth of payments without filing an amendment. That’s why your LIT will do their best to set proposal terms that you can manage in tandem with your monthly expenses (including your secured debt).
If you’re in the midst of the proposal and you’re worried that you will miss an important payment, you should talk to your LIT right away. They can help you understand the options available to correct this short-term issue so that you don’t face any of these major consequences.
If you’re still concerned about the amount of secured debt that you have to pay down, consider how to get out of mortgage debt faster. This can also help you tackle debts for home equity loans and lines of credit.
Using Home Equity Loans to Cover a Consumer Proposal:
Some homeowners use their home equity loans to pay off their other debts. So, is it possible to use your home equity loans to pay for a debt solution like a consumer proposal? Technically, yes. If you already have a home equity loan or a line of credit, you could use the funds available to help you cover your proposal payments in a short amount of time.
That said, just because you can do something, doesn’t mean that you should. Using home equity loans to complete your consumer proposal is not the best idea because, in doing so, you undermine the purpose of the proposal by taking on more debt. You’ve signed onto this process to become debt-free. The moment that you complete the proposal, you will have to tackle these secured debts that come with interest rates and consequences like asset seizure.
You are better off committing to the consumer proposal without trying to find any loopholes and easy answers. That way, you can finish the process with your unsecured debts paid in full and your secured debts in a manageable place.
Getting Home Equity Loans after a Consumer Proposal:
If you’re considering applying for a home equity loan or line of credit right after completing a consumer proposal, different lenders will have different approval criteria. Some major banks will need you to wait a period of 2 years after you’ve completed your proposal. Tier 2 banks and credit unions require a 6-month grace period. Tier 3 lenders require no delay — however, you will be subject to higher interest fees.
Home equity loans are not the ultimate debt relief solution. They carry significant risks and encourage you to make unhealthy financial choices. If you want to get relief from your unsecured debts and avoid collecting them all over again, you should talk to one of our licensed insolvency trustees. David Sklar & Associates is here to help.