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Written by Joel Kranc

What is a Home Equity Line of Credit (HELOC)?

Most, and maybe even all of us, will rack up debt in many shapes and sizes over the years. With different loans at various rates, it can be a good idea to consolidate those loans into lower interest rate loans.

A HELOC or Home Equity Line of Credit helps you do that by unlocking the equity you’ve built up in your home and offers an alternative to other personal loans such as credit cards or other lines of credit. The lender or financial institution uses your home as a guarantee that you will pay the money back.

HELOCs can also be used for big ticket items like renovations in the house, paying off personal debts, like school loans, and car loans, for example.

There are different types of HELOCs:

Most major financial institutions offer a home equity line of credit combined with a mortgage under their own brand name.

It combines a revolving home equity line of credit and a fixed term mortgage. Generally, you’ll have no fixed repayment amounts for a home equity line of credit. Your lender will generally only require you to pay interest on the money you use.

The fixed term mortgage will have an amortization period. You have to make regular payments on the mortgage principal and interest based on a schedule.

A stand-alone Home Equity Line of Credit is a revolving credit product guaranteed by your home. It’s not related to your mortgage.

The maximum credit limit on a stand-alone home equity line of credit:

  • can go up to 65% of your home’s purchase price or market value
  • won't increase as you pay down mortgage principal

You can apply for a stand-alone home equity line of credit with any lender that offers it.

The main features of a HELOC

Home Equity Lines of Credit can be a great alternative to personal loans.  The main feature of a HELOC is that the more equity you’ve built in your home, the more you can borrow.

Also, there are minimum and maximum amounts you can borrow but those vary from bank to bank. The maximum HELOC amount is calculated as 65% loan-to-value of your home, as seen in the example calculation above.

Sometimes you want to deal with different institutions. You can have something called a second-position HELOC whereby you hold your mortgage with one bank and get a HELOC with another bank.

It may also be possible to divide your HELOC into smaller portions through different sub-accounts. A sub-divided or sub-account HELOC gives you the advantage of a fixed rate, a fixed payment, and a fixed pay off schedule. Dividing up your HELOC also makes it easier to track your money.

How do I calculate my HELOC?

A HELOC in Canada can be a maximum of 65% of your home's appraised value if you borrow from a federally regulated financial institution, such as a bank. Or, if your lender combines your home equity line of credit limit with the balance remaining on your mortgage, it can be up to 80% of your home's value.


HELOC rule changes

In recent years, HELOC usage has risen to levels that regulators deem concerning. Canadian banks responded by tightening lending criteria. For example, it’s now common to approve borrowers based on them theoretically using the full amount of their HELOC limit, even though there may be no borrowing at the time of closing.

In other words, despite having a zero balance, a bank will assume you’ll use all your credit and test your ability to carry those theoretical interest costs.

The bank will also generally apply a theoretical payment based on a 25- or 30-year amortization, and make sure you can afford it—again, assuming you maxed out the HELOC.

How is getting a HELOC different from refinancing your mortgage?

By refinancing your mortgage, you'll replace your existing mortgage with a new home loan—and get the difference between the two in a lump sum of cash.

To obtain a home equity loan or line of credit, you must have equity in your home available to draw from. Determining what option is best for you can be particularly difficult, given that mortgage interest rates tend to be more favorable than those available with a home equity loan or line of credit.

A HELOC will always have a variable rate (usually your lender's prime rate + 0.5%), while the mortgage you obtain upon refinancing can be either variable or fixed-rate.

Also, HELOCs can be paid back at any time with no penalty. The only requirement is that interest payments are made on time. Refinancing, however, will also require regular payments on both the principal and interest, and while some percentage of the mortgage can be made in a lump sum ever year (often 20% of the initial mortgage amount), you will pay a penalty for paying for the entire lump sum if you choose to.

Compare HELOC rates

When shopping for any financial product, whether it’s a mortgage, credit card or a HELOC, it’s crucial to compare rates in order to get the best value possible.

There’s no downside to switching financial institutions if you find one offering mortgage and/or HELOC terms that are superior to your existing lender. However, it’s important to do the math first to ensure the move makes financial sense once you factor in fees and mortgage breakage penalties.

Mortgage rate comparison websites, such as RATESDOTCA, have tools to help you evaluate HELOC rates being offered by the major financial institutions in Canada. This helps you contrast different offers in as little as five minutes.

HELOC pros and cons

Pros

  • Flexibility: Because a HELOC is a revolving credit facility, you can borrow and repay the money as needed, with no fixed payments. You are only responsible for paying the monthly interest cost.
  • Lower Rates: HELOCs typically come with more competitive interest rates (currently about 2.95%-3.95%), which is materially lower than many personal lines of credit — and far lower than other credit options, like a credit card at 19%+ interest.
  • Emergency Fund: A HELOC can substitute a traditional cash emergency fund without you actually having to scrounge the money together and having it sit rotting in a savings account.
  • An Open Alternative: HELOCs are usually cheaper than open mortgage rates and make good short-term financing solutions when you know you’ll repay the loan within 6-12 months.


Cons

  • Fluctuating Interest: Your interest costs can rise unexpectedly if rates climb (although in economic slowdowns such as early 2009 or 2020, rates seldom rise much for years.)
  • Easy to Overuse: Because a HELOC is “revolving,” it’s very easy to dig a sizeable debt trap and become stuck there if you’re not financially disciplined.
  • Lingering Debt: Making just interest-only payments can keep you indebted for many years beyond a traditional mortgage.
  • Harder Approvals: HELOCs are harder to get approved for if you have above-average debt ratios. You need pristine credit, a reasonable debt load and fully provable income. Most lenders also require floating-rate borrowers to prove they can afford payments at the posted 5-year fixed rate. This higher “stress test” rate is used for qualification purposes in case rates soar.
    Lenders are also more careful about who they approve for HELOCs, given that there’s no set payment schedule to keep borrowers disciplined.
  • Not Guaranteed: Remember that in times of crisis or in the event the lender judges that you are misusing your credit, your financial institution can freeze your credit limit, increase the interest rate or in extreme cases, call in your HELOC.

    This is especially true if you miss any payments, your credit score is falling and/or your home value is plummeting.

Frequently asked questions about HELOCs

Have more questions about HELOCs? We have answers.

How can I find the best HELOC rate

Finding the best HELOC rate starts with sites like RATESDOTCA. We can provide information on lending institutions that offer HELOCs quickly and efficiently with some information about your loan needs.

How do payments on a HELOC work?

During the draw period, you'll make monthly payments of the interest on the amount borrowed from the HELOC. Once repayment begins, your monthly payments will cover principal plus accrued interest to pay off the total amount borrowed by the end of your repayment term. Interest payments must always be paid, and the principal can be paid off in full, at any time, without penalties.

What happens if I don’t use my HELOC? Can it be cancelled?

There are no real penalties for opening a HELOC and not using it. Some banks may incur an inactivity fee if it is never used but by-and-large, you are not penalized for having it.

Financial institutions can cancel the service if they wish to. That generally happens if you are missing payments or fraud is detected. Banks sometimes set a “draw period” on HELOC – giving you a certain amount of time from which you can draw your loan. If there is no activity during that entire time, your bank may choose to cancel the HELOC. It’s best to work out all issues about timing and repayment plans with your financial institution ahead of time.

What are the disadvantages of a home equity line of credit?

Disadvantages of home equity lines of credit include:

  • It requires discipline to pay it off because you’re usually only required to pay monthly interest
  • Large amounts of available credit can make it easier to spend higher amounts and carry debt for a long time
  • To switch your mortgage to another lender you may have to pay off your full home equity line of credit and any credit products you have with it
  • Your lender can take possession of your home if you miss payments even after working with your lender on a repayment plan

What is the maximum amount I can borrow with a HELOC?

The portion of your home that you can finance with your home equity line of credit can't be greater than 65% of its purchase price or market value. You can finance your home up to 80% of its purchase price or market value, but the remaining amount above 65% must be on a fixed term mortgage.

*Based on the difference between estimated deep-discount 5-year fixed rates from Canada's top six banks and the lowest comparable rates on RATESDOTCA, as of January 14, 2022.

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