Home Equity Line of Credit
What’s a home equity line of credit?
A home equity line of credit, commonly known as a HELOC, is a secured form of credit and its considered secured because it’s registered against your home. Instead of a credit card or line of credit where there is nothing used as a security for the revolving loan, the lender uses your home as a guarantee that you’ll pay back the money you borrow. Home equity lines of credit are revolving credit you can borrow money, pay it back and borrow it again up to a maximum credit limit.
Home equity lines of credit are usually based on the banks Prime interest Rate and the minimum monthly payment will be interest only payments.
What can I use my HELOC for?
You may be able to borrow up to 65% of your home’s market value on a home equity line of credit. This gives you the opportunity to use it towards many different goals:
Managing unexpected expenses
Using a home equity line of credit to manage unexpected expenses or emergencies, such as a job loss, means you’re borrowing money to pay for your living expenses.
You may consider using a home equity line of credit to consolidate high-interest debt, such as credit cards and car loans. A lower interest rate may help you manage your debt and get things paid down sooner.
Using home equity lines of credit to invest
Some people borrow money from a home equity line of credit to put into investments, TFSA’s and stock options. It is also a great way to borrow money at a low rate for a business start-up or to purchase other real estate investments.
How do I qualify for a HELOC?
You only have to qualify and be approved for a home equity line of credit once. After you’re approved, you can access your home equity line of credit whenever you want.
- a minimum down payment or equity of 20% in the house, in this scenario you can have a line of credit portion of to 65% of the mortgage and the other 15% must be locked into monthly payments with a fixed or variable rate traditional mortgage.
- a minimum down payment or equity of 35% if you want to use a stand-alone home equity line of credit as a substitute for a mortgage
Before approving you for a home equity line of credit, your lender will also require that you have:
Does a HELOC require an appraisal?
When you take out a line of credit on your home you can borrow up to 80% of the appraised value which means if your house appraisal comes in at $500,000 you can take out a mortgage of $400,000 on it. If you already owe $250,000 on your current mortgage that means you can take out $150,000 as the limit on the line of credit. Therefore the lender will require an appraisal to determine the current value of your home.
Different lenders have different appraisal requirements. Some lenders will cover the cost of the appraisal, whereas others will charge you upfront as part of the closing costs or roll the fee into the cost of your loan.
Can you use a HELOC as a down payment?
Yes you can definitely use your home equity line of credit for a down payment on another house.
Types of home equity lines of credit
There are 2 main types of HELOCs: one that’s combined with a mortgage, and one that’s a stand-alone product.
Home equity line of credit combined with a mortgage
Most major financial institutions offer a HELOC combined with a mortgage under their own brand name. It’s also sometimes called a re-advanceable mortgage.
It combines a revolving HELOC and a fixed term mortgage.
You usually have no fixed repayment amounts for a HELOC. Your lender will generally only require you to pay interest on the money you use.
The fixed term mortgage will have an amortization period. You have to make regular payments on the mortgage principal and interest based on a schedule.
The credit limit on a HELOC combined with a mortgage can be a maximum of 65% of your home’s purchase price or market value. The amount of credit available in the HELOC will go up to that credit limit as you pay down the principal on your mortgage.
The following example is for illustration purposes only. Say you’ve purchased a home for $400,000 and made an $80,000 down payment. Your mortgage balance owing is $320,000. The credit limit of your HELOC will be fixed at a maximum of 65% of the purchase price or $260,000.
This example assumes a 4% interest rate on your mortgage and a 25-year amortization period. Amounts are based on the end of each year.
Figure 1 shows that as you make regular mortgage payments and your mortgage balance goes down, the equity in your home increases. Equity is the part of your home that you’ve paid down through your down payment and regular payments of principal. As your equity increases, the amount you can borrow with your HELOC also increases.
Figure 1: Home equity line of credit combined with a mortgage
Buying a home with a home equity line of credit combined with a mortgage
You can finance part of your home purchase with your HELOC, and part with the fixed term mortgage. You can decide with your lender how to use these two portions to finance your home purchase.
You need a 20% down payment or 20% equity in your home. You’ll need a higher down payment or more equity if you want to finance your home with just a HELOC. The portion of your home that you can finance with your HELOC can’t be greater than 65% of its purchase price or market value. You can finance your home up to 80% of its purchase price or market value, but the remaining amount above 65% must be on a fixed term mortgage.
For example, you purchase a home for $400,000, make an $80,000 down payment and your mortgage balance owing is $320,000. The maximum you’d be allowed to finance with your HELOC is $260,000 ($400,000 x 65%). The remaining $60,000 ($320,000 – $260,000) needs to be financed with a fixed term mortgage.
Creating sub-accounts in a home equity line of credit combined with a mortgage
A HELOC combined with a mortgage can include other forms of credit and banking products under a single credit limit, such as:
- personal loans
- credit cards
- car loans
- business loans
You may be able to set up these loans and credit products as sub-accounts within your HELOC combined with a mortgage. These different loans and credit products can have different interest rates and terms than your HELOC.
You can also use your HELOC to pay down debts you have with other lenders.
It’s important to be disciplined when using a HELOC combined with a mortgage to avoid taking on more debt than you can afford to pay back.
Stand-alone home equity line of credit
A stand-alone HELOC is a revolving credit product guaranteed by your home. It’s not related to your mortgage.
The maximum credit limit on a stand-alone HELOC:
- can go up to 65% of your home’s purchase price or market value
- won’t increase as you pay down mortgage principal
You can apply for a stand-alone HELOC with any lender that offers it.
Substitute for a mortgage
A stand-alone HELOC can be used as a substitute for a mortgage. You can use it instead of a mortgage to buy a home.
Buying a home with a HELOC instead of a traditional mortgage means:
- you’re not required to pay off the principal and interest on a fixed payment schedule
- there’s a higher minimum down payment or more equity required (at least 35% of the purchase price or market value)
Using a HELOC as a substitute for a mortgage can offer flexibility. You can choose how much principal you want to repay at any time. You can also pay off the entire balance any time without paying a prepayment penalty.
Home equity loans
A home equity loan is different from a home equity line of credit. With a home equity loan, you’re given a one-time lump sum payment. This can be up to 80% of your home’s value. You pay interest on the entire amount.
The loan isn’t revolving credit. You must repay fixed amounts on a fixed term and schedule. Your payments cover principal and interest.
Qualify for a home equity line of credit
You only have to qualify and be approved for a HELOC once. After you’re approved, you can access your HELOC whenever you want.
- a minimum down payment or equity of 20%, or
- a minimum down payment or equity of 35% if you want to use a stand-alone HELOC as a substitute for a mortgage
Before approving you for a HELOC, your lender will also require that you have:
- an acceptable credit score
- proof of sufficient and stable income
- an acceptable level of debt compared to your income
Tips before you get a home equity line of credit
- Determine whether you need extra credit to achieve your goals or could you build and use savings instead
- If you decide you need credit, consider things like flexibility, fees, interest rates and terms and conditions
- Make a clear plan of how you’ll use the money you borrow
- Create a realistic budget for your projects
- Determine the credit limit you need
- Shop around and negotiate with different lenders
- Create a repayment schedule and stick to it
Advantages and disadvantages of a home equity line of credit
Advantages of HELOCs include:
- easy access to available credit
- often lower interest rates than other types of credit (especially unsecured loans and credit cards)
- you only pay interest on the amount you borrow
- you can pay back the money you borrow at any time without a prepayment penalty
- you can borrow as much as you want up to your available credit limit
- it’s flexible and can be set up to fit your borrowing needs
- you can consolidate your debts, often at a lower interest rate
Disadvantages of HELOCs include:
- it requires discipline to pay it off because you’re usually only required to pay monthly interest
- large amounts of available credit can make it easier to spend higher amounts and carry debt for a long time
- to switch your mortgage to another lender you may have to pay off your full HELOC and any credit products you have with it
- your lender can take possession of your home if you miss payments even after working with your lender on a repayment plan
Understand your home equity line of credit contract
Shop around with different lenders to find a HELOC that suits your needs.
Each HELOC contract may have different terms and conditions. Review these carefully. Ask your lender about anything you don’t understand.
Home equity lines of credit can have different interest rates depending on how they’re set up.
They usually have a variable interest rate based on a lender’s prime interest rate. The lender’s prime interest rate is set by a financial institution as a starting rate for their variable loans, such as mortgages and lines of credit.
For example, a HELOC can have an interest rate of prime plus one percent. If the lender’s prime interest rate is 2.85%, then your HELOC would have an interest rate of 3.85% (2.85% + 1%).
You can try to negotiate interest rates with your lender. Lenders will consider:
- your credit score
- income stability
- net worth
- your home’s price
- any existing relationship you may have with them
Tell them about any offers you’ve received from other lenders.
Your lender can change these rates at any time. Your lender must give you notice if there’s a change. Any change in the prime lending rate will affect your HELOC’s interest rate and your payment amounts.
Make sure you only borrow money that you can pay back. This will help you manage a potential increase in interest rates.
Using home equity lines of credit to invest
Some people borrow money from a HELOC to put into investments. Before investing this way, determine if you can tolerate the amount of risk.
The risks could include a rise in interest rates on your HELOC and a decline in your investments. This could put pressure on your ability to repay the money you borrowed.
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