What is a Home Equity Line of Credit?

Anyone who owns a home might want to know what is a home equity line of credit (HELOC). If you are looking to borrow some money for home improvement projects, large purchases, or another expense, then look to your own home. One of the biggest perks of being a homeowner and building equity is that you can use that equity to borrow money. A popular way of doing this is through a home equity line of credit.  

What is a home equity line of credit? 

A home equity line of credit, commonly referred to as a HELOC, is a type of secured credit where your mortgage lender allows you to borrow money against the equity in your home based on the value of your home. Your home is used as collateral. The guarantee that you will pay back the money that you have borrowed within the repayment period set out in your agreement with the lender. 

There are two types of HELOCs. The first is combined with your current mortgage and the second is a stand-alone product which is unrelated to your mortgage. When you get a HELOC separate from your current mortgage, it’s considered to be a second mortgage. 

There is no application fee or annual fee for a HELOC

How does a home equity line of credit work? 

As it is a credit line rather than a loan, a HELOC offers revolving credit. This means that you will be approved for a certain amount of money, but don’t necessarily have to use all of it. You can borrow what you need (up to the maximum amount) and pay it back. Once you pay it back, you have the full value available to borrow again as needed which allows for a lot of flexibility. This differs from a home equity loan where you will be given a lump sum but once it’s paid back you no longer have access to the money and would have to re-apply for a new loan.  

If you are using a portion or all of your HELOC then you will need to make monthly payments. It is possible to pay only the interest, however, it’s in your best interest to make full monthly installments to pay back the principal as quickly as possible. This will save you money on interest and allow you to access the full amount of the line of credit again when you need it in the future.  

If you default on your payments, you could lose your home. 

Why do I need a home equity line of credit?

A HELOC can be used for pretty much anything. Most people will use a home equity line of credit for big purchases or expenses. This often means home renovations or upgrades. That said, there isn’t a rule as to what you can or can’t use the money for. You can also use a HELOC for debt consolidation, university or college tuition, purchasing a car, a wedding- whatever you need.  

Keep in mind it is your home that is used as the collateral for a home equity line of credit, so if you default on your payments you could lose your home. For this reason, it’s advised to be mindful of how you use the money for your HELOC. It should be for big, important expenses, not frivolous spending and you need to ensure that you can pay the money back in a timely matter as per your contract. 

How can I get a home equity line of credit? 

You do need to be approved to get a home equity line of credit. Most big banks and lenders will offer a HELOC as an option, although they may have different names for them. 

In order to apply for a HELOC you will need:

• a minimum downpayment or equity of 20%
• a minimum downpayment or equity of 35% if you want your HELOC to be stand alone

In order to be approved for a HELOC, the lender will make sure that you have the following:

• A good credit score
• Proof of sufficient and stable income
• An acceptable level of debt compared to income

Similar to when applying for a mortgage, you will need to pass the stress test to ensure that you can afford to take on the extra payments if you get a HELOC from a bank. Credit unions or other lenders that are not federally regulated may ask you to do a stress test as well to check your income ratio in comparison to your debt.

Keep in mind that borrowers only need to be approved for a HELOC once. 

How much can I borrow? 

In Canada, a HELOC can be up to a maximum of 65% of your home’s appraised value when you borrow from a federally regulated financial institution (like a bank). However, if your lender combines your HELOC with your mortgage, it could be up to 80% of your home’s value. 

What are interest rates on a HELOC? 

One of the benefits of choosing a home equity line of credit over another type of loan is that the interest rate tends to be one of the lowest options out there. The interest rates for HELOCs are quite competitive and will be significantly lower than that of a credit card and often much lower than a personal loan. Like a mortgage, with a HELOC you can choose between fixed rate or variable interest rates and it can be open or closed. 

How do I pay back my HELOC? 

When you borrow money from your HELOC you will be required to make monthly payments until the amount is paid back in full. With a HELOC, you do have the option to make interest-only payments. However, this is not ideal. You want to ensure that you can make large enough payments to also pay back the loan so you don’t accumulate too much in interest fees. 

When you have paid back the amount in full, you will have access to borrow the entire amount again. You do not need to reapply, the ability to borrow (up to your maximum amount) will be there whenever you need it.   

Pros and cons of home equity line of credit 

Now that you know what is a home equity line of credit, you’ll want to consider the pros and cons. Here are a few things to keep in mind before you decide to go this route. 

Pros of a HELOC

• Once approved, easy access to available credit
• Often lower rates than other types of credit
• Only pay interest on the amount you borrow
• Can pay back as much as you want at any time without having to worry about pre-payment penalties
• Can borrow any amount you want up to your approved limit 

Cons of a HELOC

• You must be disciplined to ensure you make payments regularly 
• Missed payments can result in losing your home
• If you want to switch your mortgage to another lender, before you can get a new mortgage you’ll likely have to pay off your HELOC first
• Variable rates can change
• The lender can decrease your limit at any time 
• The lender can demand full payment at any time
• Credit score will decrease if you don’t make minimum payments as set out in the contract with your lender