What is a home equity line of credit (HELOC)?
A home equity line of credit (HELOC) allows you to leverage the equity you have in your home to get a loan. Often this loan comes in the form of a revolving credit line.
When you open up a home equity line of credit, your lender will use your home to secure the line of credit. This allows them to offer you a competitive interest rate. It also gives them a claim on your home should you default on your line of credit or are unable to pay the minimum interest payments on the line of credit.
In a standalone home equity line of credit, you can borrow up to 65% of the value of your home. You can withdraw and payback; however much you want from your line of credit whenever you want, provided that you don't exceed your borrowing limit. And at the minimum, when you draw from your line of credit, the only payments you have to make is the interest amount.
What are the advantages of a home equity line of credit?
There are a number of benefits to having a home equity line of credit. They include:
- Lower interest rate compared to other forms of borrowing
- On-demand access to borrow a large amount of money when you need it
- You can pay back what you borrowed on your own schedule (as long as you meet minimum interest payment requirements)
- A HELOC provides a way to consolidate all your debts into one low-interest loan.
What is the interest rate on a HELOC?
The interest rate on a home equity line of credit is variable. This means that the interest rate on your HELOC can fluctuate as the Bank of Canada adjusts their interest rates.
Lenders base their prime lending rates on the Bank of Canada's prime rate. The interest rate you will pay on your HELOC will be based on your lender's prime rate plus/minus a certain percentage.
For example, you may get a HELOC rate quote of prime + 0.5%. If the HELOC lender's prime rate is 2.45%, then the interest rate on your line of credit will be 2.95% (2.45% + 0.5%).
If you have a particularly strong credit score, a low amount of debt, and a stable job, you may be in an excellent position to negotiate a more favorable interest rate than what a lender advertises. Always shop around for the best HELOC rates and be open to negotiating with lenders as they may have wiggle room to offer you a better interest rate.
How do I qualify for a home equity line of credit?
All the big six Canadian banks offer home equity lines of credit, as well as a few of the smaller banks. They all require that you hold at least 20% equity in your home before you can apply for a HELOC.
Once you've met the 20% equity requirement, lenders will look at your credit history and your income stability before determining if they will extend a line of credit to you and for how much.
How do I get to 20% equity in my home?
The minimum equity required for a HELOC is 20%. You can achieve this 20% threshold in a few ways. You can:
- Place a down payment on your home purchase of at least 20%
- Make enough mortgage payments over time so that the equity in your home eclipses 20%
How much can I borrow from a home equity line of credit?
If you have at least 20% equity in your home, you can borrow up to 65% of your home's appraised value in the form of a home equity line of credit.
To illustrate how this works, let us assume that your home is worth $500,000 and that you carry a $350,000 mortgage balance.
First, let's see how much equity you have in your home.
- $500,000 (home value) - $350,000 (mortgage balance) = $150,000 (equity)
- $150,000 / $500,000 = 30% equity
From our calculations above, you have 30% equity in your home, which is more than the minimum requirement of 20% equity for a line of credit.
Now that you're eligible for a HELOC, let's calculate what the maximum amount you can borrow would be. To do this, we'll take 65% of your home's appraised value.
- $500,000 (home value) x 65% = $325,000
We can see above that 65% of our home's value is $350,000. This is the maximum amount we can borrow from our home equity line of credit.
How do I borrow from a home equity line of credit?
You can withdraw funds from a HELOC whenever you want, so long as you don't exceed your credit limit. The use of borrowed funds from a HELOC is entirely up to you. Some people use a HELOC to pay for home renovations, pay for education, or pay for a vacation. How you use your HELOC is entirely up to you.
Withdrawing funds from a home equity line of credit is easy. It's basically like withdrawing funds from a regular chequing account. Most lenders will allow you to withdraw cash from an ATM directly from your HELOC. Many of them also allow you to write cheques directly against your home equity line of credit. If you have online banking, you can also pay your bills and transfer funds to other accounts from your line of credit.
How do I pay back a home equity line of credit?
When you borrow from a home equity line of credit, there is no payback schedule. You pay back the principal borrowed at your convenience. At the minimum, you only need to make monthly interest payments against the outstanding line of credit balance.
As you pay down your line of credit balance, the interest you're charged every month will adjust down. If you have a zero line of credit balance, then you won't have to pay any interest charges.
Some lenders may charge a fixed monthly fee regardless of the balance on a home equity line of credit. Be sure to go over any potential fees with your lender when you're opening up a HELOC.
Can I buy a home using a home equity line of credit and a mortgage?
Some lenders will allow you to purchase a home using a home equity line of credit combined with a mortgage. With this option, you can buy a home using a revolving line of credit portion along with a fixed term mortgage portion.
With the line of credit portion, you pay back the principal when you want, so long as you meet the minimum interest charges every month. And on the fixed-term mortgage portion, you'll have to pay back like a regular mortgage over an amortized period.
To purchase a home using a HELOC and mortgage combination, you'll need to put at least a 20% down payment on the purchase. The remaining 80% of the purchase should be broken down as follows:
- The line of equity portion can account for up to 65% of the purchase price
- And the fixed-term mortgage portion should account for at least 15% of the purchase price
To get a home equity line of credit and mortgage combination, you'll still have to pass the lender's regular mortgage qualification rules along with a more stringent credit check to ensure that you can carry the additional debt obligation.
What is a readvanceable mortgage?
A readvanceable mortgage is a type of mortgage with a built-in home equity line of credit portion. At the beginning of your mortgage, depending on your down payment, your line of credit limit will be low. As you pay down your mortgage's principal balance, your line of credit limit will increase in tandem.
What are the costs of getting a HELOC?
When you get a home equity line of credit, there are a few upfront costs that you should be aware of, such as:
- Home appraisal fees
- Legal fees to register the collateral claim on your home
- Legal fees toward searching for other liens on your home
- Other administrative fees your lender may charge to set up your line of credit
When you apply for a home equity line of credit, be sure to check with your lender for setup costs and ongoing expenses that could be incurred.