Summary: What is a Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) is an easy way for homeowners to access their equity in their home for renovations, repairs, investing or whatever it is that they need the funds for.
Before you start borrowing, it’s important to understand your home equity and how a HELOC works.
What is Home Equity?
Home equity is the difference between the value of your home and the outstanding mortgage amount and/or other loans secured on it. For example, if your home is worth $400,000 and your mortgage balance is $150,000, your home equity is $250,000.
What is a HELOC & How Does it Work?
If it’s not a mortgage, what is a HELOC? A HELOC stands for home equity line of credit, or simply, “home equity line.” It’s essentially a revolving amount of credit that is secured against your home.
Lenders allow total loans (mortgage plus HELOC) of up to 80% of your home’s value. Using the $400,000 home example above with the $150,000 mortgage, your HELOC could be as much as $170,000. You can draw from that money at any time, for any reason (i.e., renovations, investing, etc.). To calculate this yourself, determine your home value, then multiply it by 0.80 then subtract the mortgage balance. The remaining amount is how much you could access through a HELOC.
With a HELOC, you’re not borrowing a lump sum upfront. Rather, you’re getting a revolving line of credit and, when you decide to access it, you can decide how much. When you do make a withdrawal, you pay interest only on the amount borrowed and HELOC rates are typically slightly higher than variable rate mortgages, which are tied to your lender’s prime rate (for more on the prime rate, click here!). To pay off the HELOC, you will need to make payments beyond just the interest payments, which you can do yourself or set up as auto-payments.
If you’re deciding if a HELOC is right for you, here are some advantages and disadvantages of using a HELOC:
HELOC Advantages:
- Access cash at a low price: Interest rates on HELOC mortgages in Canada can be lower than for other types of loans.
- Flexible access to cash: With a mortgage, everything is fixed, but with a HELOC, once you’ve negotiated the line of credit amount, you can go up to that limit whenever you want.
- Stay in your home and keep your equity: You can continue to live in your home and maintain ownership in an asset that can go up in value.
HELOC Disadvantages:
- Need to qualify: HELOC mortgages in Canada are designed for people with sufficient income to pay at least the interest on a monthly basis. This means that income-strapped individuals (retirees, for example) may not qualify even with a lot of home equity.
- Requires monthly payments: You will need to make monthly interest-only payments, but in order to start paying down your balance, you need to also make at least the minimum monthly principal payment.
- Penalties for missing payments: There can be penalties for missing a payment on your HELOC, including having your loan called. With that said, it’s important to keep in touch with your lender during financial difficulties to assess your options.
- Additional fees: In order to get a HELOC, you may be required to pay appraisal fees, application fees, and legal fees.
- Potential interest rate increase: Since the interest rate for a HELOC is variable, your interest will increase if the prime interest rate goes up.
For more in-depth information on HELOCs, check out this great resource put together by The Financial Consumer Agency of Canada (an official agency of the Government of Canada).
