Remember life before COVID-19? Like many Canadians, Anna and her husband David have been carrying a little more debt than they’re comfortable with. While their main financial responsibility is a mortgage on their Hamilton-area home, the couple also carry a balance on several credit cards and feel weighed down by what they owe. In recent months, Anna and David had talked about applying for a Home Equity Line of Credit (HELOC) or other options through their bank, but hadn’t gotten around to making an appointment with an advisor. Enter the pandemic, and the couple suddenly needs access to credit during COVID-19. As self-isolating and social-distancing measures impacted Anna’s work as a speech pathologist, their timing has become more urgent.
Changes to life and credit during COVID-19
“I’m self-employed and not considered essential,” explains Anna, noting she can no longer see clients in-person. “I am trying to do some work online to help with our cash flow, but it is taking a huge bite out of our monthly income.” Also affecting Anna’s ability to earn money is the presence of their two young children, both home due to school and daycare closures. David is an essential worker and is still working, but the couple had relied on Anna’s income to make ends meet.
The need for credit during COVID-19 is as timely as the need for proper hand-washing techniques. “Accessing money would give us peace of mind,” says Anna.
Many banks and credit companies are offering special rates and services right now, but as always, it’s best to explore your options. We spoke with Domenic Falcone, a senior financial advisor with Manulife Securities in Toronto, to discuss the risks and benefits associated with several common forms of credit available now.
Home Equity Line of Credit (HELOC)
The good: Low interest, flexible payment schedule
The bad: House is at risk for foreclosure if payments are missed
If you own a home, a Home Equity Line of Credit (HELOC) may be a good place to start, according to Falcone. Essentially a HELOC is a second mortgage line of credit valued at the equity in your home, but at a much lower interest rate than a regular line of credit. (To figure it out, take the current market value of your home minus the balance of your mortgage.)
“The credit is there as you need it,” he explains. “You don’t pay the interest if you don’t need to use it. The rates are typically lower and you can just pay interest only—in many cases, you aren’t forced to make both principal and interest.”
The specifics of your HELOC agreement will depend on the lender you choose, so it’s best to read the fine print. “In a few cases, there are HELOCs where no payments are required, however, interest is capitalized on any outstanding balance for a period of time.”
To qualify for a HELOC, you must own your home and hold a minimum of 20% equity, demonstrate proof of income and should have a good credit score. The credit available to you at any given time correlates directly to the amount owing on your mortgage, and the line itself (this is known as revolving credit). Essentially, the amount you owe on your mortgage and HELOC combined cannot exceed 80% of the value of your house or condo.
Falcone sees few downsides to accessing this type of credit, praising its flexibility and low-interest rates. That said, as with any credit, a HELOC should be used with caution. “If the cost of servicing debt is too much, it can be overwhelming. Another risk with a HELOC is that if you can’t make your payments after you’ve accessed it, you put your property at risk [for foreclosure].”
Personal loans and unsecured lines of credit
The good: Structured payment schedule
The bad: High interest rates
Falcone cautions that personal loans and unsecured lines of credits often come at a high cost—and they’re more difficult to obtain.
“These are based on one’s credit worthiness so in times of economic strain, banks tend to tighten up on general lending.” An unsecured line of credit or a personal loan through your bank will typically come at a higher interest rate than that of a HELOC. A bank loan may also lack the flexibility of other options, as it isn’t revolving and loans typically require scheduled payments over a known term.
This option may not be ideal, but it’s worth investigating, especially if you don’t qualify for lower interest credit. “If it’s a last line of resort and you can obtain one, something is better than nothing to get you through a tough period,” Falcone concedes. “Loans are really to provide a bridge to get you to the other side.” That part could be attractive for credit during COVID-19.
Borrowing from family or friends
The good: Create your own terms, low or no interest
The bad: Can strain personal relationships
If your bank can’t provide a viable solution or you’d like to go another route, borrowing money from family is a valid option for many Canadians. “I would stay away from friends, but family—by all means.”
Falcone emphasizes the importance of documentation, even with relatives you trust and love. “There have to be terms of the payback. There should be something on paper because if something bad happens, there’s documentation for the estate. This shows a promise to repay something that was lent.”
Falcone notes that unlike accessing credit through the bank, a family loan can cause strain in relationships—particularly if there’s a struggle to pay the money back, or if a parent loans money to one child and feels obligated to even things out with the siblings.
It’s also important to consider the needs of the lending family member. “Hopefully, it doesn’t put them into a financial bind, because then everyone is having financial problems.”
If everyone is clear with their expectations and situations, this can be a viable credit solution for the interim.
Low-interest and balance transfer credit cards
The good: Easy to apply for, lower interest rates
The bad: Credit card debt remains
If you’re carrying a sizeable balance on a 20%-interest credit card, it’s smart to look for low-interest alternatives. Get away from a rewards card, says Falcone. They have great rewards, but they often have higher rates, as well as annual fees, to—you guessed it!—pay for those rewards. Instead, get a low-rate, no-frills credit card, Falcone recommends.
“It might be easier to get a credit card than a bank loan,” he says. “Some have interest rates that are under 10%. Balance transfers, same thing—take advantage if you can, but it’s a stop gap measure.” Remember, too, that many balance transfer cards start off with a low promotional rate that shifts to a higher rate on remaining and new balances once the promotional period is over. If you’re out of work or your income is reduced, you might not be able to pay down the balance you transferred while the interest rate is still low, so an all-the-time low-rate card might be a better option.
What are your other options?
Falcone cautions Canadians against using third-party lenders that promise quick access to money. “Anything outside of the traditional methods of credit are short term and have a high cost that can be devastating.” It isn’t unusual for these kinds of lenders to charge an exorbitant 45% interest rate—that’s even pricier than a standard credit card.
He also recommends that whenever possible, Canadians should get a credit option in place before a crisis occurs. Although we could have never predicted the financial impact of the fast-moving COVID-19 situation, it’s about being aware of when you may be vulnerable.
Finally, Falcone advises that if you have savings, use them. After all, that’s what they’re there for. But because no one knows how long this crisis will continue, it’s a good idea to line up that credit as well; if you end up not needing to use it because your savings were enough, great. But you’ll be prepared in case you do need to dip into the credit as well.
Also, “reduce [your] expenses as much as possible, and always make [at least] minimum payments on your debts in order to maintain good credit standing and your cash flow.”
Business owners and self-employed individuals may have additional options, particularly if the shortfall is likely temporary.
“If you know that income will be returning two, three months down the road, [taking on some] debt might be your only solution,” he says, suggesting business loans. “If it’s your business, use whatever credit you can get. It can be your lifeline.”
MORE ON COVID-19:
- Where to find and apply for COVID-19 financial relief
- Managing your mortgage during COVID-19
- What should retirees do with their investments amid COVID-19
- Investing in time of COVID-19
The post Credit during COVID-19: accessing the best credit in Canada right now appeared first on MoneySense.