Everything You Need to Know About HELOCs

While most homeowners purchase property to have a place to call home, homeownership comes with other benefits. One benefit of homeownership is the ability to borrow against the equity you’ve built up in your home by using a home equity line of credit (HELOC)

A HELOC is a line of credit secured by your home equity. Because it’s a secured debt, a HELOC is generally lower interest than a credit card or a personal line of credit. The lower interest rates associated with HELOCs make them an attractive option if you need to borrow money.

How Can a HELOC Be Used?

Most HELOCs are revolving credit tools, similar to a credit card. HELOCs allow you to borrow against a spending limit and repay your balance many times. You’ll only pay interest on the amounts you borrow, and you’re required to make minimum monthly payments if you carry a balance. Like other lines of credit, the interest rate on a HELOC is variable and is usually expressed as a percentage plus the prime rate. For example, prime plus 2.45%, when prime is at 0%, is 0% + 2.45%, for a total interest of 2.45%.

HELOCs can be used for almost anything. Here are some of the common reasons Canadians apply for HELOCs:

• Purchase another property

• Do renovations

• Consolidate debt

• Finance a car purchase

• Post-secondary education for children

• Down payment support for children

A HELOC would be used and paid off over time in all of these cases.

Another type of loan against your home equity is a home equity loan. A home equity loan is not a HELOC. It is a loan for a fixed amount and a fixed-term secured with your home equity. You must pay these types of loans back on a set schedule. You’ll borrow the entire amount and make payments on the whole amount.

How is the Limit for a HELOC Calculated?

HELOCs let you access up to 65% of your home’s value, as long as the combined total of your mortgage and HELOC together does not exceed 80% of the value of your home.

To determine the potential value of your HELOC, take your home’s current market value and multiply that by 80% (0.8). Then subtract your mortgage balance. The remaining amount is the potential value of your HELOC, as long as that value is not more than 65% of your home value.

For example, if you have a home worth $700,000 with a $350,000 outstanding mortgage, you may qualify for a $210,000 HELOC. Multiplying $700,000 by 0.8 to get 560,000, then subtract this by $350,000 to get your HELOC amount of $210,000.

How to Apply for a Home Equity Line of Credit

You can apply for a HELOC either through the same lender that holds your mortgage or through a third-party lender (also known as a second position HELOC). To apply, you’ll need to provide some documentation to your lender to ensure your home qualifies for a HELOC.

The most significant qualifier for a home equity line of credit is whether you have 20% equity in your home. Since you can’t borrow more than 80% of your home’s value between your HELOC and your mortgage, you’ll need at least 20% equity to qualify for a HELOC.  If you live in a major centre like Vancouver or Toronto, your home may appreciate in value fairly quickly, so you might reach this 20% milestone even if your down payment was smaller.

Beyond equity, you’ll also need a good credit score, stable income, and an acceptable debt level. Your lender needs this information to determine if you pass a stress test, which tests your financial profile and your ability to pay back your HELOC. The stress test is based on a “qualifying interest rate,” which is the higher of either the interest rate you negotiate with your lender, plus 2%, or 5.25%.

If you pass your HELOC stress test, you’ll also need to provide proof that you own the home, your mortgage details, and you may need your house appraised to determine the fair market value.

Once all of these details are in place, you’ll be approved for your HELOC.

How Do You Pay Back a HELOC?

A HELOC is a revolving credit tool, which means that you can use as much or as little of the available credit as you need, and repay it at your own pace. You’ll need to pay at least the interest monthly, and You can typically do this via your online bank or by setting up your HELOC as a bill payee if your HELOC is with a lender that is different from your financial products.

Will a HELOC Affect My Credit Score?

HELOCs are credit tools, and like most credit tools, they impact your credit score. Your lender will report your HELOC to Canada’s credit bureaus, Equifax and TransUnion. Your HELOC will affect your credit score by influencing your credit mix, which is the different types of credit associated with your profile. A good mix of types of credit is best for your credit score. In addition, your HELOC will impact your credit utilization ratio. To have the best credit score, you should keep the debt you carry to less than 30% of your overall credit limit. Finally, if you miss a payment on your HELOC, your credit will be negatively impacted.

Should You Get a HELOC?

HELOCs are credit tools, and because your home’s equity secures them, they offer a low-cost way to borrow money. If you have an upcoming project that you are looking to fund, a HELOC could be the lowest cost way to borrow the money to do so. Just keep in mind that you’ll need to have the funds available to pay off your HELOC eventually and that it isn’t “free” money.