Money

When to Use a Home Equity Line of Credit

By Investors Group / June 2018

HELOCs come with many of today’s mortgages, and they’re so easy to use. Are you making the most of yours?

Canadians love to use home equity lines of credit (HELOCs). In fact, we’ve used them to borrow $230 billion, according to 2018 numbers from the Office of the Superintendent of Financial Institutions.

For large, unexpected expenses, a HELOC can be a better option than making a withdrawal from your RRSP.

These lines of credit allow borrowers to access up to 80 percent of the equity in their property to fund whatever they’d like. It works like a line of credit: You can withdraw funds and pay down the debt anytime you want, and it can be done all online.

HELOCs, though, aren’t always used to their full advantage. Duane Bentley, Vice-President of Banking and Mortgage Distribution for Investors Group, offers guidance on mastering the HELOC.

What is a HELOC and how does it work?

A Home Equity Line of Credit enables the borrower to access the equity in their residence. A HELOC is not available to high ratio borrowers with a down payment of less than 20 percent.

Unlike a traditional mortgage, you can access the HELOC, draw down funds and then repay without reducing the original approved credit limit. For example, with a traditional mortgage, you borrow a $400,000 standard mortgage against your principal residence and diligently pay it down. Should a situation arise where you would prefer to access the built-up equity in your property, you will need to apply to your lender for a ‘re-advance’ or ‘refinance’ that will require a thorough underwriting process similar to when you first applied for your mortgage.

However, a HELOC will remain with you and the property regardless of the debt being fully repaid. This presents a variety of planning options including the ability to access potentially tax-free funds on demand, depending on your personal financial situation.
How is a HELOC different from a Reverse Mortgage and what are the advantages and disadvantages of each?

Reverse mortgages typically pay either a lump sum payment or a regular (monthly) payment to the borrower. The borrower generally does not pay interest or principal on the loan until the property is sold, which will reduce the value of the property when it is sold or for estate valuation.

A HELOC enables a borrower to make withdrawals on demand or not all. You extract equity based on your needs and not a specific payment stream. Therefore, interest costs are lower than for a reverse mortgage and a HELOC may be portable to your next principal residence, depending on your lender’s terms.
Is a HELOC interest rate fixed or variable?

It can be both. In fact, you can have multiple options: a fixed rate mortgage term, a variable rate mortgage term and a floating rate credit line. With a HELOC, you have the ability to mitigate interest rate renewal risk, blend your interest rates in order to potentially lower your total borrowing cost and be in complete control of your lending.
Are there fees associated with obtaining a HELOC and, if so, what are they?

Similar to a mortgage, a HELOC may require an appraisal which does come with a cost that will vary based on the type of appraisal required. You will also need to have the HELOC registered against your property which will require a lawyer.
Is a HELOC the right financing choice to pay for a car, a renovation loan, or another larger unexpected expense?

Depending on your situation, it could be a great option. Interest rate charges for residential properties are typically less than retail options such as car loans or department stores. A key benefit of a HELOC is the possibility to structure your debt to reduce or repay without penalty.

For large, unexpected expenses, a HELOC can be a better option than making a withdrawal from your RRSP. A withdrawal from an RRSP would attract immediate taxes while a HELOC can allow you to get the funds you need potentially tax-free.
Which strategies are best for paying down a HELOC?

To fully maximize the true value of a HELOC, I recommend a blended interest rate and multiple term strategy. With a combination of shorter term debt blended with potentially mid-term and longer term debt, combined with the potential for both fixed and variable interest rates, you can minimize borrowing costs, maintain strategic flexibility in the face of interest rate fluctuations, and ensure the largest debt you will likely undertake during your lifetime is managed according to your objectives.