Summary: What is a Home Equity Line of Credit (HELOC)
Homeowners can easily access the equity in their home for renovations, repairs, investments, or any other financial needs through a Home Equity Line of Credit (HELOC). However, before borrowing money using a HELOC, it is essential to comprehend your home equity and the mechanics of a HELOC.
What is Home Equity?
Home equity refers to the amount of value a homeowner has built up in their property, which is the difference between the current market value of the home and any outstanding mortgage or loan balances secured against it.
To calculate your home equity, you simply subtract your outstanding mortgage and/or loan balances from the current market value of your property. For instance, if your home has a market value of $400,000 and you have an outstanding mortgage balance of $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:
- 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.
- 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).