A home equity line of credit (HELOC) is a form of credit in which your home is used as collateral, allowing you access to borrow cash against the equity of your home.
A HELOC has some similarities to a credit card. However, unlike a credit card, a HELOC is a secured loan. Due to the fact that the lender is taking the property as collateral, a HELOC will have a lower interest rate compared to a credit card. This can be beneficial in certain situations, but there are some other considerations to keep in mind to avoid risking your home.
Quick facts about HELOC in Canada
- The two main types of HELOC in Canada are the ones that are either combined with the mortgage on your home or the ones that exist on their own without being built into a mortgage. The first type is a readvanceable mortgage.
- You can borrow some money, pay some of it back, and borrow some more with a fixed maximum credit limit. Unlike the mortgage itself, the fact that a HELOC is revolving means that you can think of it similar to how a credit card works where you have a maximum credit limit, but you can borrow and make payments as you go within that limit.
- A HELOC is a secured loan. It is secured against your property. If you fail to meet your obligations, you will lose the property.
Qualifying for a HELOC in Canada
Here are the qualifications that are necessary for a HELOC in Canada.
Please note that the exact requirements may vary slightly between different lenders, and may vary depending on your unique financial situation and circumstances, but the following information can serve as a good outline so that you know what to expect if you’re considering a HELOC in Canada.
You will usually be able to access 80% of the equity that you’ve built in your home by making payments towards your mortgage or if you’ve already paid off your mortgage in its entirety and are looking to gain access to some cash. In some areas, this could be as low as 65%, meaning the amount of money you can borrow against the equity in your home is lower when compared to the total equity you’ve accumulated.
The reason for this 80% cut-off is to protect lenders from being underwater in the event that the borrower is unable to repay the loan and the real estate markets have fluctuated to a point where the value of the property has declined. That extra 20% cushion makes it very unlikely for a lender to lose out—even if they end up having to repossess the home and sell it on the market.
Other factors include your credit history and a credit check. If your credit history has had blemishes since the time you initially took out your mortgage, then it could be more difficult to get a line of credit. Your current debt to income ratio will be taken into account. This will be along with a more recent appraisal of the value of your home. If the conditions that allowed you to take out your initial mortgage have changed drastically, then that could make it slightly harder to get a HELOC.
When to use a HELOC
- This is a useful tool when you need some cash for important purchases, want to make improvements to your home, or have emergencies like a surprise root canal that you don’t want to put on a credit card. Additionally, a HELOC is useful for things that you will be able to pay off with your current budget.
- Some people opt to use a HELOC as a substitute for taking out a mortgage. The difference is that a mortgage has a fixed schedule for paying the principal value of the mortgage and the interest. With a line of credit, those fixed payment terms don’t exist. If you’re using a HELOC, then instead of a 5% to 20% down payment that you would require with a mortgage, you’ll need a down payment of at least 35% and possibly more.
- If you aren’t sure how much money you’ll need, or when you’ll need it, then a HELOC is a great choice. It’s commonly used for things like home upgrades and repairs because you’re able to draw the exact amount you need and exactly when you need it.
When to not use a HELOC
- We’ve made the credit card comparaison a handful of times already, but it’s not a great idea to use your HELOC the same way you would use a credit card. This is especially true if you’re turning to a HELOC because you have maxed out your cards.
- The interest rates are lower with a HELOC so in that sense, it makes sense to carry the balance here instead of with a credit card if we’re just looking at the raw numbers, but it’s worth looking a little deeper than that. If you’re using it for vacations, luxury spending, electronics, and other things that can add up very quickly, especially if you’re living above your means, then a HELOC can be a lot worse than credit card debt. Sure, the interest is high with credit cards, but not making payments towards your HELOC can result in you losing your home.
HELOC versus home equity loans
Don’t confuse a home equity line of credit with a home equity loan. They are different financial products altogether. The key difference is that with a home equity loan, you receive a lump sum of money at once. You pay interest on that entire amount throughout the life of the loan. If some of that money is going to be sitting, then you’re still paying interest on it.
With a HELOC, on the other hand, you borrow what you need and when you need it. You’re only paying interest on the money you’ve spent.
Home equity loans are a good choice for paying a large, fixed expense at once. If you have a child who needs money for their tuition, you suddenly need a new furnace, or if you need a new vehicle, then a home equity loan fits the bill. It has a fixed interest rate. Additionally, your monthly payments will stay the same until it is fully paid off.
On the other hand, a HELOC is the better option when you either don’t have a fixed price for your expense or it’s an ongoing cost. For a set period of time, you’ll have access to a revolving amount of cash that you can spend at your discretion. The interest rate is variable, so your monthly payments towards a HELOC can change as time passes.