What is a HELOC (Home Equity Line of Credit)?
A home equity line of credit (HELOC) is a type of loan that allows you to borrow money against the equity in your home.
HELOCs are a revolving line of credit, which means you can borrow money, repay it, and then borrow it again. This can be a convenient way to access cash for unexpected expenses, potential investments or for larger projects, such as home renovations.
How does a HELOC (Home Equity Line of Credit) work?
When you get a HELOC, the lender will set a credit limit for you. This is the maximum amount of money you can borrow. You will then be given a HELOC account, which you can use to borrow money as needed.
When you borrow money from your HELOC account, you will start to accrue interest on the amount you owe. The interest rate on a home equity line of credit is typically variable, which means it can change over time. Generally speaking, the interest rate will only fluctuate when your country's central bank changes interest rates. This means that your interest rate could actually decrease as well as increase.
You will need to make regular payments on your HELOC, just like you would with any other loan. The amount of your monthly payment will depend on the amount of money you have borrowed, the interest rate, and the term of the loan.
Most lenders will require you to make interest-only payments on the amount of money you have borrowed. Other lenders require you to pay 2% or 3% of the loan back per month. Interest-only payments are one of the most beneficial aspects of a HELOC, so be sure to request interest-only payments from your lender when you set up the HELOC.
The Pros and Cons of a HELOC (Home Equity Line of Credit)
Pros:
HELOCs can be a convenient way to access cash for unexpected expenses or for larger projects.
The interest rates on HELOCs are typically lower than the interest rates on credit cards or other types of unsecured personal loans.
HELOCs can be a good way to consolidate debt, such as credit card debt, into a single loan with a lower interest rate.
Cons:
HELOCs are secured loans, which means your home is used as collateral. If you default on your payments, the lender could foreclose on your home.
The interest rates on HELOCs can change over time, so you could end up paying more interest than you originally thought.
If HELOCs are not utilized over a long period of time, your lender may close the HELOC, and therefore, you will need to requalify for it again.
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How to get a HELOC (Home Equity Line of Credit)
To get a HELOC (Home Equity Line of Credit), there are a few things you need to do:
Have good credit and enough equity in your home. This means you should have a good track record of managing your debts and own a significant portion of your home.
Apply for the loan and get approval from the lender. The lender will check your credit score, income, and how much of your home you own to decide if you can get the credit line.
Keep in mind that in Canada, HELOCs usually max out at 65% of your home's value. For example, if your home is worth $1,000,000, the most you can borrow with a HELOC is $650,000. But this doesn't guarantee you'll be approved for the full amount.
It's smart to compare different lenders before choosing one. Most big banks have similar rules. If your credit score is lower or your income isn't high enough, there are other lenders called 'B lenders' who might help. Talk to a local mortgage broker to explore these options. They can also assist you with HELOCs from your local bank. Always make sure you understand all the loan terms and conditions before signing anything.
Is a HELOC (Home Equity Line of Credit) right for you?
A HELOC can be a good option for people who need to access cash for unexpected expenses or for larger projects. However, it is important to weigh the pros and cons carefully before you get a HELOC. If you are not sure whether a HELOC is right for you, you should talk to a mortgage advisor and financial team.
Here are some additional things to consider when deciding whether or not to get a HELOC:
Your financial situation: Make sure you can afford the monthly payments on the HELOC, even if the interest rates go up.
Your plans for the future: If you are planning to use your home equity for investments, renovations or expenses in the future, setting up a HELOC now could be a good step.
Your risk tolerance: Make sure you are comfortable with the debt payments and are able to manage the risk that is associated with borrowing money.
Example of a HELOC (Home Equity Line of Credit):
Borrower: John and Jane own a home worth $500,000. They have a mortgage balance of $150,000, so they have $350,000 in equity.
Credit limit: The lender approves them for a HELOC with a credit limit of $100,000. This means they can borrow up to $100,000 against their home equity. They now have total loan limits of $250,000 secured against their home. A loan-to-value ratio of 50%.
Interest rate: The interest rate on the HELOC is variable, and it is currently 7.5%.
How to use: The HELOC is a revolving credit line, which means they can withdraw money from the line of credit whenever they choose. John and Jane can also withdraw different amounts, depending on what they need.
Repayment: John and Jane's HELOC requires them to pay at least the interest amount every month. This means they will only cover the interest cost, and their payment will not reduce the principal amount. If they borrow the entire $100,000 in this scenario, their monthly payment would be $616.43/month. This is calculated using the following equation: (($100,000 * 7.5%)/365)*30 = $616.43.
If you don't want to complete this calculation manually, feel free to use our HELOC calculator from our Mortgage Mastery Kit. The calculator can be found in the "Debt Consolidation Calculator."
TL;DR
A HELOC is a revolving loan that allows you to borrow money against the equity in your home multiple times.
The interest rates on HELOCs are typically lower than the interest rates on credit cards or other types of unsecured personal loans.
HELOCs can be a good way to consolidate debt, such as credit card debt, into a single loan with a lower interest rate.
If you decide that a HELOC is right for you, be sure to use it wisely and repay it as quickly as possible. This will help you avoid paying too much interest in the long run.
Questions/Comments?
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