What is a Home Equity Line of Credit and how does it work?
HELOCs are becoming increasingly popular with Canadians, as they are flexible and easy to use. But what is a home equity line of credit, exactly, and how can you make the most of it?
Canadians love to use home equity lines of credit (HELOCs). In 2021, the amount of money Canadians owed to HELOCs had risen to just over $260 billion.
These lines of credit allow borrowers to access up to 80% of the equity in their property, with the freedom to spend the money in any way they choose. It works in a similar way to a personal line of credit: you can withdraw funds and pay down the debt anytime you want.
While HELOCs offer a flexible borrowing solution, they aren’t always used to their full advantage. We answer some of homeowners’ most frequently asked questions to help you to make the most of your HELOC.
What is a HELOC and how does it work?
A home equity line of credit allows homeowners to access the equity in their home. HELOCs aren’t available, however, to high ratio borrowers (those with a down payment of less than 20%).
Unlike with a traditional mortgage, you can access a HELOC to draw down funds and then repay them without reducing the original approved credit limit. For example, with a traditional mortgage, you take a $400,000 standard mortgage against your principal residence and diligently pay it down. If you then needed to access the built-up equity in your property, you would have to apply to your lender for a refinance or re-advance, which would require going through the underwriting process, similar to when you first applied for your mortgage.
However, with a HELOC, the full amount remains available up to the original authorized borrowing limit, even after you repay what you owe. This presents a variety of financial planning options, including the possibility of accessing low-cost, tax-free funds on demand.
While HELOC rates tend to be a little higher than conventional mortgage rates, you will pay considerably less in interest on a HELOC than you would on most personal loans, unsecured lines of credit and credit cards.
What is a HELOC’s biggest benefit?
This would arguably be its convenience and flexibility. You can withdraw and pay back money whenever you want and for any purpose, without having to re-apply to your financial institution (once your HELOC is approved).
Low HELOC rates are another key advantage, particularly compared to credit cards and unsecured loans.
What is a HELOC’s advantage over a reverse mortgage?
Reverse mortgages are targeted at homeowners who are aged 55-plus, whereas HELOCs are available to all qualifying homeowners, regardless of age. Reverse mortgages are typically paid out in either a lump sum or in monthly payments. The borrower generally doesn’t have to make regular payments on the loan (although they can choose to), but interest grows on the full balance of the loan, which results in higher overall interest costs. Reverse mortgages are generally paid off when the property is sold, which would reduce the value of their property when it’s sold or is valued as part of an estate.
With a HELOC, you can make withdrawals on demand or not touch it at all, it’s your choice. You take out equity based on your needs and not a specific, predefined amount. This means you are only charged interest on the amount you choose to withdraw, as opposed to a reverse mortgage, where you borrow a large lump sum up front and accrue interest on the full mortgage amount. Also, HELOC interest rates are typically lower than for a reverse mortgage, and a HELOC may be portable to your next principal residence, depending on your lender’s terms. A reverse mortgage has to be repaid when you move out or sell your home.
Are HELOC rates fixed or variable?
They can be both. In fact, you can have multiple options: a fixed rate term, a variable rate term and a floating rate credit line. With a HELOC, you can help mitigate interest rate renewal risk by incorporating both fixed and variable interest rates, in order to potentially lower your total borrowing cost, should rates rise, and be in complete control of your borrowing.
What is a HELOC’s cost to arrange?
Similar to a mortgage, a HELOC may require an appraisal, which does come with a cost that will vary based on the type of appraisal required. You will also have to register the HELOC against your property, which will require a lawyer and bring with it legal fees.
Some financial organizations (including IG Wealth Management) will offer to cover costs for clients that apply for a HELOC.
Is a HELOC the right financing choice to pay for a car, renovations or other large, unexpected expenses?
Depending on your situation, it could be a great option. Interest rate charges for HELOCs are typically less than loans for cars or department store credit. A key benefit is the ability to consolidate higher interest debt into the HELOC and reduce or repay your debt on your own schedule and without any penalty.
For large, unexpected expenses, a HELOC can certainly be a better option than making a withdrawal from your RRSP. A withdrawal from an RRSP would trigger immediate tax implications, while a HELOC can allow you to get the funds you need tax-free. You can also set up your HELOC into multiple sub-accounts to track projects and expenses separately and ensure you stay on budget.
What are the best strategies for paying down a HELOC?
To fully maximize the benefits of a HELOC, a blended interest rate and multiple term repayment strategy could be the best option. A combination of shorter-term debt, blended with potentially mid-term and longer-term debt, would give you the potential to benefit from both fixed and variable interest rates.
Some financial products that include a HELOC (such as IG’s Solutions Banking All-in-One) allow clients to create unlimited sub accounts, to help mitigate interest rate risk, give you full control over how you repay, and help you stay organized.
This would help you to minimize borrowing costs, maintain strategic flexibility in the face of interest rate fluctuations, and ensure the largest debt you will likely undertake during your lifetime is managed according to your objectives.
How to weigh up the pros and cons of a HELOC
Bay & Associates will work with you and our expert Mortgage Planning Specialists to advise on which financing solution best meets your needs, and how to get the most out of a HELOC.
In addition to third parties, we offer a HELOC product in the form of the Solutions Banking All-in-One. The All-in-One isn’t just a HELOC though, it offers the features of a chequing account, savings account, mortgage and line of credit, all in one convenient product.
Arrange a meeting with us to discuss the best financial options for you.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
Banking products and services are distributed through Solutions Banking™. Solutions Banking products and services are provided by National Bank of Canada.
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Mortgages are offered through I.G. Investment Management, Ltd.* Inquiries will be referred to a Mortgage Planning Specialist (in Ontario, a Mortgage Agent, and in Quebec, New Brunswick and Nova Scotia, a Mortgage Broker).
*In ON and NS, registered as a Mortgage Brokerage (ON 10809, NS 3000240) and a Mortgage Administrator (ON 11256, NS 3000232), in QC, registered as a financial services firm (QC 2400376104) and in NB, registered as a Mortgage Brokerage.