August 17, 2017
What the Heck is a HELOC? 5 Tips for Borrowers
Let’s say you’ve owned your home for several years, dutifully paying your mortgage each month, and building up equity in your property. Did you know that you can cash into your home’s value, effectively taking out a loan against the equity you’ve paid into?
What is a HELOC?
A HELOC, or Home Equity Line of Credit, is a mortgage product that is registered and secured to a primary property, and in some cases a rental property. It is usually a loan placed secondary to your existing mortgage, and is typically for an amount larger than $35,000, at an interest rate between 3.20 and 5.50 per cent. You can typically take out a maximum of 65 per cent against the value of your property, and the process is very similar to being approved for a traditional fixed or variable-rate mortgage, with the borrower providing their mortgage professional adequate income documents, proof of down payment with a 90-day account history, and other personal information.
HELOC vs. LOC
HELOCS are similar in nature to non-secured lines of credit (LOCs), in that they’re both open revolving loans, but there are a few key differences. LOCs, which are typically used for student loans, car loans, or minor repairs around the home, are usually only for amounts below $35,000, with rates between 5 – 8 per cent. Both are variable-rate products. which tie into the Bank of Canada’s (BOC) overnight prime lending rate. That means their interest rates fluctuate when the BOC’s mortgage rate increases or decreases.
However, a HELOC is secured against your home’s equity; the maximum 65-per-cent loan is a threshold that still provides a borrower with 35 per cent equity remaining in their property should the housing market correct, house prices decrease, or the borrower needing extra equity for unforeseen emergency circumstances such as an illness, marital split, etc. and may need access to money should they need to sell the home.
How do HELOC Payments Work?
Paying off a HELOC is similar to a credit card – the debt is revolving, meaning there’s no amortized timeline or deadline to pay it off, though it does need to be repaid before you can sell the home.
You are required to only pay the minimum interest amount – but like a credit card, it’s smart to always repay more than the minimum. Keep in mind that when you apply for a HELOC for say, a limit of $100,000, the lender will assume that that entire $100,000 is being used, and so you will be qualified based on that full amount even if you only use a portion or none at all.
The great thing about a HELOC versus a traditional mortgage product is that once you are approved for your HELOC and it closes you will only repay the used portion of the HELOC. So in continuing with the example of a limit of $100,000, if you only use $20,000, then the monthly balance you must repay is based on that $20,000, and compounded monthly.
And, because it is an open term, should you choose to break your HELOC term, you won’t have to pay an Interest Rate Differential (IRD) penalty, as you would with a fixed-rate mortgage, or three-months’ worth of interest penalties as you would with a variable-rate mortgage.
Related Read: How to Calculate Your Mortgage Penalty
What Should You Use a HELOC for?
HELOCs can be used for whatever purpose you wish. Some typical uses for them include:
- Paying for renovations or minor updates to your home
- Putting kids through post-secondary school
- Paying for a wedding
- Financially helping an elderly parent
- Paying off existing debts
- Purchasing investment
Regardless of what you use the funds for, a smart practice is to not to exceed 85 per cent of your maximum loan – doing so can leave your financially vulnerable, and indicates you aren’t responsible with your debt ratios.
Who Should Get a HELOC?
It’s also important to not use your HELOC as a personal bank machine, withdrawing money without the intention of paying it back. Remember, it’s cash pulled out of your home’s equity, and will need to be paid back before you can sell your home – otherwise your home’s title will register a debt against it, and won’t clear during the transaction.
Biting off more than you can chew in a HELOC can put you in serious financial jeopardy, and blow your hard-earned sweat equity, so it’s important to be honest with yourself before taking out this kind of loan; if you’re the type to spend your max and pay only minimum payments, then a HELOC is not for you – in this case I would suggest a fixed-rate mortgage.
If you know you’ll use a HELOC responsibly, though, and will pay back more than the minimum required payment, it can be an excellent alternative to traditional mortgage products and loans.