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What is a HELOC?
Sometimes, for various reasons, we need to borrow money to cover significant expenses where amounts are higher than one would ask from family or friends to save on interest payments. Some of us take personal loans, but consolidating debt becomes expedient at some point. A mortgage option can help close the outstanding balance through a tool offered by various financial institutions — a second mortgage.
Even if a mortgage is not fully repaid, owning a property is an asset that helps to get the amount needed without selling the item. The mortgage portion that must be repaid to the lender is determined by the lender's terms and the specification of the loan product. A HELOC or a Home Equity Line of Credit is a line of credit secured by a house, apartment, or land as well as the first mortgage. Based on the property price minus the outstanding mortgage, the lender approves a limit for the borrower. In other words, a HELOC is a second mortgage that gives you access to cash based on the home's equity belonging to you.
A regular installment of the home equity loan of credit consists of interest-only payments, and the limit set by the lender can be revolving, which means that borrowers can use the money again after repayment within the draw period.
The HELOC process starts with an application, new appraisal, credit checks in respect of existing mortgage loan and overall debt ratio, agreeing on the terms and repayment period, payment frequency, etc., and finally getting funds available during the draw period.
Of course, the borrower will not usually use the credit limit for 100% of the property value, multiple lenders offer on average 85%, but it saves time and costs compared to other loan products since the same collateral is used. This type of loan allows paying only for the part of the credit used.
However, this credit product also implies some risks. Yes, one can draw down the amount needed to cover expenses incurred during the drawdown period, but the interest rate on the Home Equity Line of Credit is variable. This means that the amount of regular payments can be different each time, whereas with a home equity loan where you are given a one-time lump sum payment, the interest rate is fixed, and the amount of periodic payments is known, and stable over the life of the loan.
Major types of HELOCs in Canada
Financial institutions, HELOC lenders, offer the following types of this mortgage-based product:
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an equity line of credit combined with a mortgage loan (requires at least 20% of the equity in the real estate);
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revolving and non-revolving credit lines;
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a stand-alone line of credit;
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with optional credit insurance and a mandatory one (the insurance covers job loss, disability, and death).
Let us describe some of these products in detail.
Several credit products are associated with mortgage financing or other significant expenses. As mentioned earlier, it is a HELOC, but financial institutions have more to offer. For example, a Home Equity Line of Credit can be combined with a mortgage. It is a combination of two credit products: a mortgage paid at a fixed interest rate and a flexible line of credit. In total, the borrower bears the cost of regular mortgage payments in the form of interest, principal, and interest on the revolving line of credit. Regular payments on the mortgage loan increase equity and the ability to use loan funds when permitted by the financial institution's loan terms.
A home equity loan can be combined with personal loans, credit card products, auto loans, and loans for business purposes. However, borrowers must check the total cost of the outstanding loans, as they are usually paid at different interest rates. Each new loan is usually more expensive for the borrower with the same lender.
Another attractive loan option is a stand-alone equity line of credit. This is both a revolving line and a HELOC. Typically, the limit is up to 65% of market value, and a new property appraisal is required. Unfortunately, there is no way to increase the available limit even if you repay a more significant portion of the mortgage. This financial product is so interesting because you are not required to apply for it only with your mortgage lender. You can also apply for it at any other financial institution that offers such a product and whose eligibility criteria the borrower meets.
The stand-alone line of credit can be used to purchase a property as a traditional mortgage alternative.
The advantage of the HELOC is that there is no penalty if the borrower repays the loan early. The stand-alone loan is also more flexible in this regard and saves money on penalties, which are typically thousands of dollars.
Remember to calculate the cash needed and any required fees for loan disbursement and processing, such as attorney and notary fees.
Note: A home equity loan is not the same as a home equity line of credit. A home equity loan implies you get a one-time lump sum payment. This can be up to 80% of your home’s value. You pay interest on the entire amount. The loan isn't revolving credit. You are to repay fixed amounts under a fixed term and schedule. A fixed-rate HELOC is considered a hybrid sitting between a traditional HELOC and a home equity loan.
A cash-out refinance is not the same as a HELOC. A cash-out refinancing pays off your original mortgage in exchange for a new one, preferably at a lower interest rate.
How to apply for a HELOC in Canada?
A home equity line of credit can be obtained from the following home equity lenders:
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banks;
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credit unions;
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other lenders.
Applications can be submitted online or offline directly at a HELOC lender office. Also, some mobile apps allow you to submit your application and get pre-approved. Check out what options are allowed by your lender.
Requirements
Basic requirements for a home equity line of credit mean:
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maturity age;
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documentary confirmed permanent residence or citizenship in Canada;
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the borrower must be able to sign legally binding documents;
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the borrower has to own around 20% of home equity in your mortgage balance;
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stable job;
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sufficient income, which allows to service the loan and successfully repay it at some point;
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good payment history;
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low debt ratio;
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excellent-good credit score.
This is a basic list; for more details, the borrower should check the lender's web page or other official sources that provide relevant information about the lender's products and eligibility criteria.
In Canada, there are federal laws and provincial regulations which are applied to various loans. In addition, the Criminal Code of Canada provides information about the maximum interest rate.
It might be helpful to remember that the Financial Consumer Agency of Canada can be applied if you consider that your rights were violated.
According to the B-20 guideline, there is an update about the maximal amount the borrower can get within their HELOC's draw period. On the revolving basis, it means no more than 65% instead of 80%, and LTV should be more than 65%. If the LTV ratio is below this benchmark, then part of the payments would have to go to repay the mortgage loan's principal. Debt amortization should be applied for the debt above the 80% benchmark.
Ways to get a HELOC in Canada
The borrower has to apply to the lender and check the eligibility criteria for a home equity line of credit at the bank, credit union, another lender, etc. Typically, banks have more strict eligibility requirements than alternative lenders.
How to repay a HELOC?
Paying off a home equity line of credit requires discipline and good financial planning.
One has to make efforts to repay not only interest but also regularly contribute to the principal.
Repayment can be performed:
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online;
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using web banking;
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using a mobile app;
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via cheque;
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through the lender’s cash desk.
Pros and cons
Pros
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Using the same property as collateral, borrowers can get money more than once at relatively low-interest rates;
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The interest rate on home equity lines is usually lower than online loans and some other loan products;
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home equity lines of credit allow consolidation of high-interest debt;
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the verification procedure on the part of the lender for home equity lines is simpler than when approving a mortgage loan;
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it is possible to pay only for the used amount of the credit, unlike a home equity loan;
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it is possible to pay monthly installments consisting of interest only;
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in some cases, it is an excellent alternative to the sale of real estate;
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it is possible to repay the loan early;
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An equity line of credit is a loan to value among existing home loans;
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HELOC funds are offered by a variety of lenders (credit unions, banks, other lenders);
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repayment periods are discussed with the lender and can be tailored for the convenience of loan repayment;
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the loan period can be over 15 years, and it allows for balancing monthly payments
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if the loan is revolving, the borrower can repay and use the money again within the limit and during the drawing period;
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if the loan's variable interest rate declines in line with market trends, the borrower will make less than expected interest payments.
No loan products are 100% universal, meeting all the market needs. Still, an equity credit line allows flexibility while financing home improvements and tuition and getting more money within HELOC's draw period.
Cons
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the amount of the loan depends on a portion of the mortgage paid off and your actual equity;
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equity Lines of Credit is a variable rate loan product, which means that the cost of credit is not entirely predictable and changes with market fluctuations (variable interest rates often mean rising interest rates following market interest rates);
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consolidating high-interest loans using a home equity lines of credit would incur additional costs required to obtain the loan (appraisal fees for a new appraisal, even if you have recently obtained an appraisal for your primary mortgage);
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each additional loan with the same lender usually means a higher interest rate because it represents a higher risk to the borrower (remember that interest rates rise);
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there are often calculation fees;
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draw period ends;
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most lenders say that to enjoy a low-interest rate (even an initial one), the borrower has to give an excellent - good credit score;
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interest paid late would mean restrictions from the lender;
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cancellation fees may be high;
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if you want to get out of debt, you need to lay aside money towards the principle (remembering both the principal and interest);
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under tax law, the borrower can deduct interest only if this loan is used for home improvement.
Disadvantages of equity line loans are associated with additional fees. Also, mortgage payments grow when the market interest rate increase.
The real cost of a HELOC
A home equity line of credit disbursed by financial institutions (HELOC lenders) is a popular loan product for debt consolidation. The cost of an equity credit line consists of more than interest payments. It is worth mentioning that home equity loans lender would require payment of:
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appraisal fee (market changes and value of real estate never remain unchanged);
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credit report fees;
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paperwork fees (depends on the lender);
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fee for applying and application processing;
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early pay-off fee;
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insurance cost.
All fees related to a home equity line of credit make up the total cost of the loan. Some expenses are one-time, and others are recurring. A credit calculator can give general information about loan costs, but more details should be obtained from the lender's specialist before signing a loan agreement.
Note: Only a comprehensive comparison of different lending options gives solid ground to understand what works best for you (fixed payments due to fixed interest rate or floating interest rate which follow market interest rates increase), needed loan amount, bearable fixed monthly payment, and consequently the total cost of the loan.
