A home equity line of credit, or HELOC, allows you to borrow against the equity of your home at a low cost. Unlike a mortgage or home loan, it's a flexible line of credit and you can use it only when you need to.
* For mortgages of at least $500,000 with down payment under 20%.
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† For mortgages of at least $500,000 over a 25-year amortization period.
A home equity line of credit provides you with a line of credit with a pre-approved limit (like a credit card). Also like a credit card, you can draw from and pay back into it whenever you want. There is, however, no grace period where you won’t be charged interest until a certain date – the moment you withdraw from the HELOC, interest starts accruing. Compared to mortgages, HELOCs tend to have higher interest rates. They are also usually only offered as variable rates, although some lenders allow you to convert part of your HELOC into a home loan with a fixed rate and term.
In Canada, you can only borrow up to 65% of your home's value with a HELOC. When combined with a mortgage, your Cumulative Loan To Value (CLTV) cannot exceed 80%. This means that your mortgage and HELOC combined cannot exceed 80% of your home's value. If you owe 50% of your home value on your mortgage, you would be eligible for a HELOC of up to 30%. Below is the formula used:
*Maximum HELOC Amount is up to 65% of home's market value
If you do not use a combination mortgage-HELOC product or have additional loans secured by your home (i.e. a second mortgage), your HELOC limit may be different from the above calculations. Credit unions and other non-federally-regulated lenders may also use different criteria for determining your HELOC credit limit.
Although you could potentially qualify for a credit limit of up to 65% of your home's value, your real limit may be subject to a stress test similar to the mortgage stress test. Banks and other federally regulated lenders will use the higher of either:
Refinancing your mortgage allows you to borrow a lump-sum at an interest rate that is usually lower than what you would be able to get on a HELOC. Unlike a HELOC, however, you will have to make regular payments torwards your mortgage that include both principle and mortgage payments. With a HELOC, you can make interest-only payments, significantly reducing the amount you have to pay back each month. This can be helpful if you will only be able to make a repayment sometime in the future, like in the case of renovating your home.
Mortgages also often come with pre-payment limitations and penalties. You will not be able to pay off the amount you borrowed immediately, and it will continue to accrue interest. A HELOC, on the other hand, gives you the flexibility to borrow and pay off the credit whenever you want.
While both a HELOC and a second mortgage use your home equity as collateral, a second mortgage can offer you access to a higher total borrowing limit at a higher interest rate. This can be up to 95% of your home's value compared to the 65% limit for a HELOC. The differences between the HELOC as a line of credit and the second mortgage as a loan still apply: with a HELOC, you are free to borrow and repay on your schedule while you can only borrow a fixed lump-sum from a second mortgage and have to repay it on a fixed schedule.
Applying for a HELOC could potentially affect your credit score. It acts as a revolving line of credit, similar to a credit card, and a high utilization rate can negatively impact your credit score. If used correctly, however, it can decrease your total credit utilization rate and act as a positive indicator of good borrowing behaviour.