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How do payments on a HELOC work?
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What are the disadvantages of a home equity line of credit?
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Jamie David, Director of Marketing & Mortgages
A home equity line of credit is one of the best ways to access the equity you’ve built up in your home, and a low-cost alternative to other lines of credit like credit cards or personal loans. However, it’s important to know some details about HELOCs before you decide to take one out.
Here's everything you need to know about getting a HELOC in Canada. When you're ready, use the tools at the top of this page to receive personalized quotes from multiple providers.
Highlights from the Bank of Canada's December 7, 2022 Announcement
On December 7, 2022, the Bank of Canada increased the key overnight rate by 0.50%. The target for the overnight rate is now 4.25%.
- Canadians with home equity lines of credit (HELOCs) will see their rates rise accordingly by 0.50%. They should calculate what their new mortgage payment is.
- The Bank of Canada's most recent announcement marked a shift in tone from previous announcements, in which future rate hikes were virtually guaranteed. Instead, the Bank has signalled that it will be considering whether the policy rate needs to rise further. This means that it is possible that there will not be another rate hike at the Bank's next announcement on January 26, 2023.
What is a HELOC?
A home equity line of credit (HELOC) is a revolving line of credit that allows you to borrow the equity in your home at a much lower interest rate than a traditional line of credit. By taking out a mortgage with a HELOC feature, you’ll have access to a pre-approved amount of cash within your mortgage. When you use the money from a HELOC, you’ll have to pay the interest on it on top of your regular mortgage payments. HELOCs come with variable rates that are usually higher than those for regular variable-rate mortgages.
How do I calculate my Home Equity Line of Credit (HELOC)?
As per the Office of the Superintendent of Financial Institutions (OSFI), a HELOC can give you access to no more than 65% of the value of your home. It's also important to remember that your mortgage loan balance + your HELOC cannot equal more than 80% of your home's value.
To see how this works, let's look at an example:
The maximum amount of equity you could pull from your home through a HELOC is $105,000.
Now, you still need to make sure that $105,000 doesn't exceed 65% of your home's value. To be sure, simply divide the HELOC amount by the value of your home:
In this example, you could access $105,000 through a HELOC, as it only amounts to 30% of your home's value.
Comparing HELOC products
As well as the rate of a HELOC, you'll also need to consider the features of any product you're considering. You can compare the different HELOC products in the chart below to find one that suits your needs. A description of the compared features can be found under the table.
All home equity lines of credit are different, and you always need to check the features of any HELOC that you’re considering taking out. Below are some of the features that can differ between different HELOC products:
- Minimum and maximum amounts: The minimum amount of a HELOC varies from bank to bank, with some institutions not offering the product at all. The maximum HELOC amount is calculated as 65% loan-to-value of your home, as seen in the example calculation above.
- Revolving balance: HELOCs are described as having a revolving balance, because borrowing multiple times within the account for any amount up to the allowable credit limit does not require writing a new loan document. The credit limit can also be increased as the equity in your home grows.
- Sub-divide lines: It is sometimes possible to divide up your HELOC into smaller portions through different sub-accounts. An example of where this may be used is if you wanted to draw out equity to invest in the stock market. In this case, the interest you pay on borrowed money is tax-deductible, so having a separate account makes it easier to track the money.
- Option to convert to fixed: You can sometimes convert a portion of your outstanding borrowed HELOC funds to a fixed rate, which you will then pay like a standard mortgage.
- Second position HELOC: This means that you can hold your mortgage with one bank and get a HELOC with another bank. A HELOC is not necessarily a “second mortgage". A "first" or "second" mortgage is used to refer to the loan's claim position. A HELOC is often second position because there is another mortgage on the property at the time. However, it is possible to have a HELOC in first position. HELOCs usually have higher interest rates because it is assumed that they will be in second position and, as a result, are riskier to the lender. In the case of you defaulting, the lender in second position is not repaid until the first position lender is.
How is getting a HELOC different from refinancing your mortgage?
Refinancing your mortgage is very different from obtaining a HELOC. Here are some of the main differences:
- If you refinance, you can borrow a lump sum that typically has a lower rate than you could get on a HELOC. Unlike a HELOC, your monthly fee will include payments towards both the principal and the interest; with a HELOC, you only have to pay towards the interest. This can make a big difference in your monthly payments.
- A HELOC will always have a variable rate (usually your lender's prime rate + 0.5%), while the mortgage you obtain upon refinancing can be either variable or fixed-rate.
- Refinancing lets you borrow more as part of your new mortgage, which gives you the cash up front. A HELOC, on the other hand, is a mechanism that allows you to access the cash at a later date.
- Mortgages frequently include pre-payment limitations and penalties, which vary from lender to lender, and product to product. In general, you will not be able to pay off the mortgage early or make lump sum payments without any penalty. In the case of a HELOC, you can pay off as much or as little of the principal as you want, when you want.
Is it better to get a HELOC or to refinance?
Refinancing to access equity might suit you if you need a lot of money in the short term, but you’ll be paying interest on it right away. A HELOC is better if you don’t need the money immediately, because you won’t have to pay interest until you actually access the cash. However, HELOC rates tend to be higher than the rate you’d pay by refinancing. You can read more about how to choose between a refinance, a HELOC and a second mortgage on our blog.
Is a HELOC right for you?
As with any other major financial decision, before you take out a HELOC, think about your financial needs and your current situation. A HELOC is a great option if you want flexibility and think you may be able to pay it off early. For example, if you're obtaining a HELOC to perform renovations on your home prior to selling it, the value added to your home outweighs the amount you will have to pay in interest on the HELOC.
Because of its flexibility and low monthly payments, a HELOC may be a better choice than a conventional loan in some situations. For example, for many parents in Canada, obtaining a HELOC is a useful vehicle to assist their children in making a down payment on a first home.
If you're unsure as to whether getting a HELOC is the right choice for you, it helps to speak with a mortgage broker, who can give you expert, personalized advice for free.
Jamie David, Director of Marketing and Head of Mortgages
Jamie has 15+ years of business and marketing experience. She contributes her mortgage expertise to The Globe and Mail and authors Ratehub’s mortgage and homebuying guides. read more
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