What is a home equity line of credit and how does it work?

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.

For large, unexpected expenses, a HELOC can be a much better option than making a withdrawal from your RRSP.
 

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.

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. 

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.

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.

Your IG Consultant can advise you on how to integrate your mortgage into your overall financial plan and can also connect you with an IG Mortgage Advisor, who can advise you on the best mortgage option for your circumstances.

If you don’t have one, you can find an IG Consultant here, and you can also contact an IG Mortgage Advisor here.