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A Home Equity Line of Credit (HELOC) is a revolving amount of credit secured against your property. The lender uses your home as collateral to ensure that you’ll repay what you owe. Homeowners commonly use a HELOC to consolidate debt, invest, or to access extra cash.
A HELOC allows you to borrow a maximum of 65% of your home’s appraised value. In Canada, a HELOC usually doesn’t have an amortization period. Once you draw on your home equity line, you will have to make at least monthly interest payments.
When deciding on a home equity line of credit there are two options. You can get a HELOC that is combined with your mortgage or select a stand-alone product.
Many lenders provide a HELOC that combines a fixed term mortgage with a revolving home equity line of credit. There is typically not a fixed monthly repayment schedule for a home equity line of credit, however, the lender requires you to pay interest on the amount borrowed. There is an amortization period on the fixed term mortgage, and payments on the principal and interest are determined by the schedule.
A home equity line of credit combined with a mortgage has a maximum credit limit of 65% of your home’s appraised value. For instance, you bought a house for $500,000 and put down $100,000, making your mortgage balance $400,000. The credit limit of your home equity line of credit will be fixed at $325,000 or 65% of the property value.
While you pay down on your mortgage, your balance goes down and your home equity goes up! But that’s not all, as the equity in your home increases so does the amount you can borrow from your HELOC.
You can pay for part of your new home with your HELOC and part with the fixed term mortgage. Decide with your lender how to allocate these two portions to fund your home purchase.
To start, you need at minimum a 20% down payment or to have 20% equity in your home. The portion of your home that you can fund with your HELOC can be no greater than 65% of its market value. You can finance your home up to 80% of its market value, but any amount that exceeds 65% must be on a fixed term mortgage.
So, if, you purchase a home for $500,000 with a $100,000 down payment, your outstanding mortgage balance is $400,000. The most you’d be permitted to finance with your home equity line of credit is $325,000 ($500,000 x 65%). The remaining $75,000 ($400,000 – $325,000) ) has to be financed with a fixed term mortgage.
A stand-alone HELOC is a revolving line of credit secured against your home but not connected to your mortgage. A stand-alone home equity line of credit also has a maximum credit limit of 65% of the homes market value but does not increase when you make payments on your mortgage
In some cases, homeowners use a stand-alone HELOC as a substitute for a mortgage. A home equity line of credit can offer you more flexibility than a traditional mortgage. Using a HELOC for a mortgage means:
● no fixed repayment schedule or prepayment penalty
● you can pay as little as the monthly interest fees
● you must pay a down payment or equity of least 35% of the purchase price or market value
One drawback of using a HELOC to pay a mortgage is that if the prime rate goes up, your monthly payment will also increase. Whereas, with a fixed rate mortgage if the prime rate changes there is no impact on your monthly payments.
To qualify for a home equity line of credit you’ll need:
● a minimum down payment or equity of 20%, or
● a minimum down payment or equity of 35% if you’d like to us a stand-alone home equity line of credit as a substitute for a mortgage
Before you can be approved for a HELOC, your lender will need proof that you have:
● a good credit score
● sufficient and stable income
● an acceptable debt to income ratio
Approval for a HELOC at a bank requires you to pass a “stress test”. The lender needs to see that you can afford payments at a qualifying interest rate, usually higher than the rate in your contract. The bank must use the higher interest rate of either:
● the Bank of Canada’s conventional five-year mortgage rate, or
● the interest rate you broker with your lender plus 2%
Lenders that are not federally regulated, such as credit unions, may or may not to use this stress test when you apply for a HELOC. Unlike banks, they are not required to use this measure.
If you want to use the equity in your home to get a HELOC, you’ll also be required to:
● proof that you a home owner
● provide your mortgage details, including the current mortgage balance, term and amortization period
● have your lender appraise your property value
You will need a lawyer, notary or a title service company to register your home as collateral. Contact us at DLC First Pacific Mortgage for more details.
Optional credit insurance can help pay off all or part of the remaining balance owing on your HELOC in the event of:
● job loss,
● injury or disability,
● critical illness, or
Your lender may offer it, but you do not need to buy optional credit insurance to be approved for a HELOC.
There are limits on the coverage that optional credit insurance products provide. It is important to read the terms and conditions carefully before purchasing these products. If you have questions, ask your broker about anything you don’t understand.
Before you sign up for optional credit insurance, you should:
● check whether you have comparable coverage through your employer
● compare other insurance products, to determine which one offers the best value for your particular needs
While taking out a home equity line of credit can be tremendously advantageous for homeowners, in the short and long-term alike, pursuing this option under the wrong circumstances can cause you a lot of grief. Your situation is unique, take all the time you need to consider whether it is truly the right choice for you.
One of the biggest issues to consider before applying for a home equity line of credit is deciding how to optimize the funds. There are a few questions you should ask yourself to help you determine whether taking out a HELOC is a practical investment for you.
● Decide whether extra credit is the most feasible means to achieve your goals. Could you compile and use savings instead?
● If you do opt for more credit, consider factors such as flexibility, terms and conditions, interest rates and fees
● Plan out how you’ll use the money
● Outline your budget for planned projects
● Decide how much credit you will need
● Create a repayment schedule you can keep up with
A home equity line of credit is a convenient way for homeowners to use their borrowing power. Advantages of a HELOC include:
● easily accessible credit
● you can consolidate your debts
● you only pay interest on the amount you borrow
● you can repay what you borrowed without a prepayment penalty
● you have the flexibility to borrow up to your maximum credit limit when you need it
● lower interest rates than unsecured loans and credit cards
● it requires discipline to pay off more than the minimum monthly interest
● large amounts of available credit can create poor spending habits and allow you to carry debt for a long time
● to switch your mortgage to another lender you may have to pay off your full HELOC and any related credit products
● your lender can take possession of your home if you miss payments even with a repayment plan
● variable interest rates can cause your monthly interest payments to increase
● your lender can reduce your credit limit at any time
● your lender has the right to demand that you pay the full amount at any time
● your credit score will decrease if you don’t make the minimum payments as required by your lender
Typically, a home equity line of credit has a variable interest rate based on a lender’s prime interest rate. For example, if your lender’s prime interest rate is 2.95%, and your HELOC has an interest rate of Prime +1 %, then your HELOC would have an interest rate of 3.95% (2.95% + 1%).
Your lender can change these rates at any time provided they give you advance notice of any forthcoming changes. Any change in the prime lending rate will affect your HELOC’s interest rate and your monthly payments. Be sensible about borrowing only as much as you can afford to repay.
The applicable fees may vary between HELOC products. The most common fees include:
● home appraisal or valuation fees: Your lender charges this fee to send an appraiser to assess your home’s value
● legal fees: Your lawyer or notary, or title service agency charges this fee to register the collateral charge on your home
● title search fees: This is another legal fee to ensure there are no liens on your property
● administration fees: Your lender charges this fee for setting up and retaining your account
● credit insurance fees: Otherwise referred to as premiums for optional life, critical illness, disability and job loss insurance
● discharge or cancellation fees: Your lender or your notary charges this fee if you cancel your home equity line of credit and remove the collateral charge from the title of your home
A home equity line of credit is commonly used to consolidate high-interest debt, like personal loans or credit cards. A lower interest rate may help you manage your debt, but it is not a solution to what caused the debt in the first place. Consider taking steps to improve your spending habits.
One of the most important steps in paying off debt is to establish a payment plan. You can convert a portion of your home equity line of credit into debt with fixed repayment amounts, similar to a mortgage loan. The interest rate and terms of the debt can differ from that of the HELOC.
Many homeowners borrow from a home equity line of credit to finance investments. Before choosing to invest using this method, assess your tolerance for risk. A rise in interest rates on your HELOC and a decline in your investments could put pressure on your ability to pay back what you owe.
You may be given a card that makes it easy for you to access the funds in your HELOC. Similar to a regular banking access card, you can use it to make purchases, get cash from ATMs and perform routine online banking transactions. Your lender may also supply you with a cheque book.
With a home equity line of credit, interest is calculated daily on the funds you borrow. Your lender may give you a credit card that is attached to your home equity line of credit combined with a mortgage. These credit cards may have a higher interest rate than your HELOC but typically offer a lower interest rate than most credit cards.
If you decided to transfer your mortgage and a HELOC when your mortgage came up for renewal, you’ll likely have to pay legal, administrative, discharge and registration fees as part of the transfer.
Before you can cancel your home equity line of credit you are required to pay it off. You can typically cancel within 10 days of taking out the HELOC, when you provide written notice. Consult your mortgage broker about terms and conditions for more specific information about cancelling your HELOC.