If you are a homeowner and are looking for a secured loan, a home equity line of credit (HELOC) might be what you need.
A HELOC is a form of secured loan that allows you to use your home equity to obtain a loan.
However, before applying for a home equity line of credit Canada, there are many things you need to know to avoid costly mistakes.
Here I discuss everything you need to know about a home equity line of credit in Canada based on my personal experience and what I have seen work for others.
At the end of this post, you should decide whether a HELOC is perfect for you or one of its alternatives.
What is Home Equity?
A home equity refers to the market value of your home based on the outstanding balance of your mortgage.
So the more you make payment against your mortgage balance, the more your home equity increases.
That said, your home equity can also increase due to your home value increase.
Thus, the better your home equity, the better your option for a home equity line of credit or home equity loan.
Most home equity offers have fixed terms covering the period you can borrow money. But at the end of the term, you’re expected to renew the credit line.
However, you cannot borrow more money if the plan does not allow renewals. Some offers may require you to repay the entire balance once the period has ended.
A home equity line of credit is one of the major types of home equity loans out there. So what is HELOC? What are the pros and cons of HELOC?
Continue reading to find answers to these questions and more.
What is a HELOC?
A HELOC refers to a secured form of credit where your home guarantees the lender that you will repay the loan.
With a HELOC, you can take a loan, repay and retake until you reach a maximum limit.
Furthermore, you can use a HELOC as the cheapest option of consolidating your current debt, but you must be disciplined to keep to the terms, else you risk your home.
That said, a HELOC often comes with a variable rate that can fluctuate in the long run, changing the interest rates. This is because the credit line is subject to the lender’s prime rate.
How Does a Home Equity Line of Credit Canada Work?
A home equity line of credit in Canada requires an application from the borrower through a bank or financial institution.
Different lenders have different requirements, and your loan will be determined by your home equity and other factors (outlined below).
So the more your home equity, the more loan options you have. As mentioned previously, your mortgage payment and home value increase determine your home equity.
With a HELOC, you are only expected to pay a monthly interest rate and the full amount at the end of the loan term. However, the interest rate changes as per the prime rate.
That said, your banks and other federally regulated financial institutions offer a HELOC up to 65% of your home value.
On the other hand, other lenders add your outstanding mortgage balance with your HELOC, covering up to 80% of your home value.
Moreover, a home equity line of credit Canada has some of the following administrative fees:
- appraisal fees
- legal fees
- title insurance fees
- title search fees
Types of Home Equity Lines of Credit in Canada
Here I discuss the two major types of home equity lines of credit in Canada to help your evaluation.
1. Home Equity Line of Credit Combined with a Mortgage
Otherwise known as readvanceable mortgage, this type of HELOC combines a fixed term mortgage and a revolving home equity line of credit.
While your HELOC has no fixed repayment amounts, a fixed-term mortgage requires you to make regular payments on the interest and principal per an amortization period and schedule.
That said, you can receive up to 65% of your home equity when a HELOC is combined with a fixed-term mortgage.
A home equity line of credit and fixed-term mortgage are two ways to finance your home purchase. However, you need to discuss this with your lender to know how to go about this.
The minimum down payment or equity is 20%. But if you want to finance your home only with a home equity line of credit, you will need a higher down payment or more equity.
That said, a home equity line of credit in Canada can’t be used to finance more than 65% of the value of your house. But you can get up to 80% of your home value with a fixed-term mortgage.
2. Stand-Alone Home Equity Line of Credit
This refers to a home equity line of credit Canada that’s solely on your home equity without a mortgage.
So you can get up to 65% stand-alone home equity line of credit worth your home value. However, the rate will not increase when you pay down your principal mortgage.
When you want to buy a home, you can use a stand-alone home equity line of credit rather than a mortgage.
Thus, using a stand-alone home equity line of credit to buy a home means you don’t have to worry about principal and interest payments on a fixed schedule.
However, you need to make more down payments or have more home equity to use a stand-alone home equity line of credit.
Pros of HELOC
- Lower interest rates compared to credit cards and unsecured loans.
- Interest-only payment.
- High loan amounts (up to your maximum credit limit).
- Flexible payment schedule (you can pay back the loan at any time without a penalty).
- Easy access.
- Can be used for debt consolidation.
- Customizable to fit your needs.
Cons of HELOC
- Highly risky if you’re not financially disciplined.
- You may lose possession of your home if you miss a payment.
- Your credit score may decrease if you miss a monthly payment.
- Increase of monthly payments due to variable interest rates.
- You may be required to pay the complete amount at any time.
What are the Requirements for HELOC?
In addition to having a 20% minimum equity or down payment, you need to meet the following requirements to qualify for a home equity line of credit in Canada:
- Good credit score
- Proof of stable and sufficient income
- Proof of homeownership
- Home assessment by your lender
- Pass a “stress test (bank requirement)
- Mortgage details
- An acceptable amount of debt
How to Borrow From a Home Equity Line of Credit?
Once your application is accepted by a bank or your chosen financial institution, you can borrow money from a home equity line of credit any time you want based on your credit limit.
Thus, you decide what to use the HELOC for. You can use it to renovate your home, finance your children’s education or even consolidate your existing debt.
That said, you can withdraw money from your HELOC through an ATM or cheques. You can even transfer the funds to other accounts or pay your bills using online banking.
How to Cancel Your Home Equity Line of Credit
Each lender has its cancelling terms and conditions. This means the cancelling process varies from one lender to another.
But before cancelling your home equity line of credit, you’re expected to pay off the loan. Most lenders allow you to cancel your HELOC after ten days of paying off the loan.
If a home equity line of credit (HELOC) doesn’t meet your borrowing needs, you have other options to choose from.
Here are three alternatives to the home equity line of credit in Canada.
1. Home Equity Loans
Unlike a home equity line of credit, a home equity loan is not a revolving credit. With a home equity loan, you will get up to an 80% one-time loan worth your home value.
However, you must repay the fixed amount on the fixed date, covering the interest and principal.
One of the benefits of home equity loans is low-interest rates. With a fixed interest rate, you don’t have to worry about interest increase in the long run.
To qualify for a home equity loan, you must meet specific requirements and pass the approval process.
Once you’re approved, the complete amount of the loan will be deposited into your bank account.
2. Second Mortgage
As the name implies, a second mortgage is an additional mortgage to your existing mortgage. You can get a second mortgage worth 80% of your home value, excluding your outstanding mortgage balance.
Since a second mortgage doesn’t erase your first mortgage, you must pay off your first mortgage after paying off your second mortgage.
The major drawback of collecting a second mortgage is losing your home if you fail to meet your payment.
Furthermore, second mortgages often have higher interest rates than the first mortgage since it’s riskier.
3. Reverse Mortgage
Finally, you can use a reverse mortgage as an alternative to a home equity line of credit in Canada. With a reverse mortgage, you can get up to a 55% loan worth your home value.
However, you must be at least 55 years old and be a homeowner to qualify for a reverse mortgage.
Unlike a regular mortgage, a reserve mortgage has higher interest rates and fees. The interest rates can be fixed or variable.
A lender may let you reborrow money you prepaid on your mortgage. This means that you can reborrow all the payments you made on your mortgage. However, the money you reborrowed will be included in your total mortgage.
That said, you can choose to continue paying your mortgage interest or a blended interest, which is a combination of your new term interest and your current interest.
Furthermore, you may not be required to change your mortgage term with a reverse mortgage.
HELOC vs. Alternatives: Which to Choose?
First, you need to consider your needs and financial situation. Accordingly, you can’t make a wrong choice with either HELOC or its alternatives.
That said, a HELOC is ideal if you’re not certain about how much you need to borrow or when you need the money. This is because HELOC allows you to borrow money anytime up to your credit limit.
But if you’re certain about the amount you need and when you need the money, you can take a home equity loan, a second or reverse mortgage.
If you’re taking a home equity line of credit, ensure you:
- Create a plan on how to use the fund
- Determine the right credit limit
- Compare different offers
- Create repayment schedule
On the other, before taking any loan, you should ask your potential lender questions about the:
- Best interest rates
Preferably, it’s essential to consult an expert if you’re still in doubt about which loan to take. An experienced and licensed REALTOR ® such as the Ken Morris Team can help you choose the perfect loan based on your needs and financial situation.
Final Thoughts on HELOC in Canada
A home equity line of credit in Canada is ideal for homeowners looking for low-interest revolving credit with a flexible payment schedule.
While HELOC has easy access, it’s not suitable for everyone. If you’re not financially disciplined enough to keep up with your monthly payment, you may lose your home with HELOC.
Thus, you should only consider HELOC if you’re financially disciplined and are not sure how much money you need at a time.
But if the reverse is the case, I advise you to consider HELOC alternatives.
Overall, your loan vehicle should reflect your financial situation and needs. So don’t hesitate to seek professional guidance when confused on which loan to take.
The Ken Morris Team is always available to help you make a cost-effective financial decision to protect your real estate and overall financial well-being.
Contact us at (403) 804 7314 or email us at KenMorris@royalLepage.ca for a customized solution.