HELOC is a term you maybe have heard from a friend, broker or on the news. It stands for Home Equity Line of Credit. But what exactly is a HELOC? Below is a quick summary of this mortgage product, what it is, and how it works:
The Basics:
A home equity line of credit is similar in many ways to a personal line of credit or credit card. The main difference is that it is “secured” by real estate. That is to say it is registered against the title of the property the same way a mortgage would be. A home equity line of credit can generally be much larger than a personal line of credit. This is because the lender holds an interest in the home it is secured against. It allows them to have recourse against the real estate if payment isn’t made. Where as on a personal line of credit, there isn’t anything of value covering the debt other than the borrower’s promise to pay.
Generally home equity lines of credit are at a much lower interest rate than a credit card or personal line of credit. The interest rates are usually “prime” and “prime + 1%”. Currently that would equate to 2.45% – 3.45%. These rates are generally only available if the line of credit is in first position (ie. there is no existing mortgage) OR if the holder of the line of credit also holds the mortgage. For example, if we had a mortgage with TD bank and also a line of credit with TD bank then we could get best rate. If you had a mortgage with TD bank and tried to get a line of credit from Scotiabank they either wouldn’t offer you the product or would offer it at a higher interest rate.
A home equity line of credit operates similar to a personal line of credit in that you may get a card to use, cheques to use, and may have it used to pay bills.
Qualifying for a HELOC:
An application for a HELOC can be done at the time of purchase or as part of a refinance. You must have at least 20% equity in your property in order to apply for a home equity line of credit and the actual line of credit can form no more than 65% of the value of the home. Qualifying for a HELOC is similar to a mortgage. Qualifying is based off income, credit and other debts. Here is an example. For a property worth $100K and clients putting $40K down payment. Since we have more than 20% downpayment we can request a line of credit for the difference. It would look like this:
Purchase Price: $100K
Downpayment: $40K
Mortgage: $60K
Available HELOC: $20K
Payments on the HELOC:
Generally payments on a HELOC are based off of minimum interest only payments. No principal pay down is required. This means that making the minimum payment on HELOC will keep the principal outstanding the same forever!
Why a HELOC:
Here are some of the reasons our clients have either added a HELOC with a refinance or purchase:
1. Emergency funds. The HELOC can sit empty usually at little or no cost to the borrower. This way funds can be used incase of emergency (ie. job loss, accident, family member needs help, etc)
2. Renovations. A HELOC can be a great option for clients planning a renovation but unsure of what the final costs would be. Instead of taking our a large sum of money in a mortgage and then paying interest right away, they can get a HELOC and then use it when they are ready to do the renovation.
3. Investment. Some of our financial planner partners often recommend HELOC’s to their clients. If used for investing purposes the interest payable on the HELOC may be tax deductible. Often returns on investments can out pace the costs of interest on the HELOC. We also suggest you consult with professionals if you are interested in this (ie. an accountant and financial planner). We can recommend some awesome people to work with.
4. Purchase of another property. Having a HELOC ready to go can be easy access to funds for a deposit or downpayment for a new home or rental property. It is important to remember that the HELOC will reduce what you qualify for on a new property since technically your are borrowing funds for the downpayment. Check with us to help you crunch on all the numbers!
Why Contact Us?
Not all lenders offer HELOC’s and not all HELOCS are created equal. Please reach out to us anytime if getting a HELOC is something that interest you. We can look at options and compare various lenders for you.