Last updated: June 27, 2022
A home equity line of credit (HELOC) is a convenient way of using the value in your home as leverage to borrow money. A HELOC provides you with a secured line of credit with a pre-approved limit and allows you to borrow the equity in your home at a lower interest rate compared to a traditional personal line of credit. They are also usually only offered as variable rates, however some lenders will allow you to convert part of your HELOC into a home loan with a fixed rate and term. Similar to a credit card, a line of credit is revolving credit which allows you to withdraw and pay back into your HELOC whenever you want. Typically HELOCs have interest only payments required, which you will need to pay back on a monthly basis, on top of your regular monthly mortgage payments.
Home equity is the amount of ownership of a property you have established through appreciation and the reduction of your mortgage principal, as the more you pay off your mortgage the more equity you will build. If you take the current market value of your home and deduct the remaining balance of your mortgage, you will get your home equity amount.
If you owe $200,000 on your mortgage and your home is worth $500,000, you have $300,000 in home equity.
A HELOC is a convenient way of leveraging the value in your home to borrow money you might need. It generally has lower interest rates and generous repayment terms and will conveniently allow you to access large amounts of money when you need it. These features are possible since they’re secured by your home. The amount of money you can borrow is limited by the value of your home and you should technically be able to pay off your HELOC in full at any time, by selling your house if needed.
If you reside in Canada, you can only borrow up to a maximum of 65% of your home’s value with a home equity line of credit. If you combine your HELOC with your mortgage, your Cumulative Loan to Value (CLTV) cannot be more than 80% of your home’s value. So if you owe 50% of your home value on your mortgage, you would be eligible for a HELOC of up to 30%.
There are a variety of reasons why someone would get a HELOC. Some common reasons to apply for a home equity line of credit:
A home equity loan gives you a one-time lump sum of money while a home equity line of credit provides convenient ongoing access to funds for current or future needs.
Once you’re approved for a line of credit, you can use the funds as you need them and repay the line of credit with interest only on the funds you use. Some HELOCs have the option of an “automatic limit increase” – where as you pay down your mortgage, that equity gets transferred into the limit of the HELOC, and you will see the limit increase each month.
If you have a HELOC limit of $100,000, and your monthly mortgage payment is $2,000, the following month after your mortgage payment, your new HELOC limit would increase to $102,000.
Since a HELOC is a revolving line of credit, the principal borrowed amount can be paid off in full at any time. Payments can be done manually each month via online bill payments/transfers, or automatically deducted from your bank account upon setting it up with the bank.
With a HELOC, you can choose to use as little or as much as you want and you only have to pay interest on the amount you have withdrawn. Interest is determined by the variable rate attached to Prime and can also change anytime at the discretion of your lender.
Both a home equity line of credit and a mortgage refinance will allow you to access the equity in your home. However they both function and operate differently.
When you refinance your mortgage, you are able to borrow a lump sum at a mortgage interest rate that is usually lower than what you would be able to get on a HELOC. However, with a refinance, you will have to make regular payments to your mortgage which will include principal and mortgage payments and need to pay interest right away. With a HELOC, you can make interest-only payments which can reduce the amount you have to pay back each month.
A HELOC is based on an interest rate set by the lender prime rate and can vary depending on the lender, meaning a HELOC’s rate is variable. So if your lender increases its prime rate, then your HELOC’s interest rate will also increase. Rates are also typically higher than the rate of the initial mortgage. A HELOC will allow you to access cash at a later date if needed while a refinance lets you borrow more as a part of your new mortgage. Its important to note you may not re-borrow funds on your mortgage without a full refinance application. A HELOC allows you to re-borrow and re-pay anytime you want after it’s set up.
Refinancing your mortgage might be a good idea if you need a lot of money immediately, but keep in mind you will need to start paying interest right away. A HELOC is a better option if you don’t need money right away or are making a large purchase but don’t know exactly how much you will need. You won’t need to pay interest until you actually need the cash, but keep in mind that interest rates are much higher compared to refinancing rates.
The nation’s federal banking regulator, The Office of the Superintendent of Financial Institutions (OSFI) has just made adjustments to its guidelines and has increased borrowing restrictions for a variety of Real Estate Secured Lending Products (RESL), which includes reverse mortgages and combined loan plans (CLP).
These changes are part of an effort to ensure federally regulated financial institutions (FRFI) are prepared for any systemic economic risks or shocks, and will be done by tightening their underwriting requirements to limit the equity amount property owners are able to access.
The OSFI has asked the FRFI to make their innovative mortgage products safer and sustainable over the long term. CLPs, which is a combination of a traditional amortizing mortgage and a home equity line of credit (HELOC), are of particular interest in this change. Under B-20 Guidelines, the maximum revolving amount borrowers can access will be limited to 65% which is a 15% difference from the previous 80%. If you have an existing CLP, you will still have access to the revolving portion of your loan but if you have an existing LTV above 65%, a part of your payments will start to go towards your principal mortgage amount until the LTV is below that threshold, upon which it will not be re-advanceable.
New CLP applicants won’t be able to access more than revolving 65% LTV at their loan origination and any debt up to 80% must be amortized like a traditional mortgage. The 65% LTV limit will also apply to new reverse mortgage applicants. Borrowers will not be impacted by this repayment term until their CLP is up for renewal, depending on their lender’s fiscal year after October or December 2023.
According to the OSFI, the majority of borrowers who use CLPs will not be impacted by these changes. The biggest impact this change will have is for borrowers who want to re-advance their principal amount to a HELOC, once they pay down the principal in the amortization portion. Effective 2023, borrowers will no longer be able to do this unless they get a re-advanceable from a non-federally regulated lender that doesn’t follow OSFI’s rules, such as a credit union.
The changes to Guideline B-20 for all lending above 65% LTV be amortized, is intended to limit the extent and duration of borrower indebtedness thereby limiting FRFI’s exposure.