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When to use a Home Equity Line Of Credit

Popularity of HELOCs

Canadians love to use home equity lines of credit (HELOCs). In 2021, the amount of money Canadians owed to HELOCs had risen to just over $260 billion.

These lines of credit allow borrowers to access up to 80 per cent of the equity in their property, with the freedom to spend the money in any way they choose. It works in a similar way to a personal line of credit: you can withdraw funds and pay down the debt anytime you want.

While HELOCs offer a flexible borrowing solution, they aren’t always used to their full advantage. And at other times they are abused too much as well. To help understand these products better, let’s take a look at homeowners’ most frequently asked questions about HELOCs:

What is a HELOC and how does it work?

A home equity line of credit allows homeowners to access the equity in their home. HELOCs typically aren’t available, however, to high ratio borrowers (those with a down payment of less than 20 per cent).

Unlike with a traditional mortgage, you can access a HELOC to draw down funds and then repay them without reducing the original approved credit limit. For example, with a traditional mortgage, you take a $400,000 standard mortgage against your principal residence and diligently pay it down. If you then needed to access the built-up equity in your property, you would have to apply to your lender for a refinance or re-advance, which would require going through the underwriting process, similar to when you first applied for your mortgage.

However, with a HELOC, the full amount remains available up to the original authorized borrowing limit, even after you repay what you owe. This presents a variety of financial planning options, including the possibility of accessing low-cost, tax-free funds on demand.

What is a HELOC’s biggest benefit?

This would arguably be its convenience and flexibility. You can withdraw and pay back money whenever you want and for any purpose, without having to re-apply to your financial institution.

Low HELOC rates are another key advantage, particularly compared to credit cards and unsecured loans. While they tend to be a little higher than conventional mortgage rates, you will pay considerably less in interest than you would on most personal loans, unsecured lines of credit and credit cards.

What is a HELOC’s advantage over a reverse mortgage?

Reverse mortgages are targeted at homeowners who are aged 55-plus, whereas HELOCs are available to all qualifying homeowners, regardless of age. Reverse mortgages are typically paid out in either a lump sum or in monthly payments.

The borrower generally doesn’t have to make regular payments on the loan (although they can choose to), but interest grows on the full balance of the loan, which results in higher overall interest costs. Reverse mortgages are generally paid off when the property is sold, which would reduce the value of their property when it’s sold or is valued as part of an estate.

With a HELOC, you can make withdrawals on demand or not touch it at all, it’s your choice. You take out equity based on your needs and not a specific, predefined amount. This means you are only charged interest on the amount you choose to withdraw, as opposed to a reverse mortgage, where you borrow a large lump sum up front and accrue interest on the full mortgage amount. Also, HELOC interest rates are typically lower than for a reverse mortgage, and a HELOC may be portable to your next principal residence, depending on your lender’s terms. A reverse mortgage has to be repaid when you move out or sell your home.

Are HELOC rates fixed or variable?

They can be both. In fact, you can have multiple options: a fixed rate term, a variable rate term and a floating rate credit line. With a HELOC, you can help mitigate interest rate renewal risk by incorporating both fixed and variable interest rates, in order to potentially lower your total borrowing cost, should rates rise, and be in complete control of your borrowing.

Is a HELOC the right financing choice to pay for a car, renovation or other large, unexpected expense?

Depending on your situation, it could be a great option. Interest rate charges for HELOCs are typically less than loans for cars or department store credit. A key benefit is the ability to consolidate higher interest debt into the HELOC and reduce or repay your debt on your own schedule and without any penalty.

For large, unexpected expenses, a HELOC can certainly be a better option than making a withdrawal from your RRSP. A withdrawal from an RRSP would trigger immediate tax implications, while a HELOC can allow you to get the funds you need tax-free. You can also set up your HELOC into multiple sub-accounts to track projects and expenses separately and ensure you stay on budget.

But at the same time, this is often where people end up abusing HELOCs by looking at them as “free money” with no plan on how to pay it off later. A HELOC requires far more restraint and self-control most times versus a traditional mortgage.

How do you weigh up the pros and cons of a HELOC?

A financial planning professional can work with you to advise on which financing solution best meets your needs, and how to get the most out of a HELOC if it’s deemed to be the most appropriate type of loan for you.

Ideally, these conversations should occur before you approach a mortgage broker so that the right solution can be determined by taking into account your overall financial plan.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.

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About the Author

Brett, designated as a chartered investment manager and certified financial planner, is the regional director (Okanagan) for IG Wealth Management.

In addition to his “day job," Brett was appointed to the board of directors of FP Canada (formerly FPSC) in 2014, named as the board’s vice-chair in 2017 and took over as board chairman in 2019. 

Brett has been writing a weekly financial planning column since 2012 and provides his readers with easy to understand explanations of the complex financial challenges that they face in every stage of life.

Enhancing the financial literacy of Canadian consumers is a top priority of Brett’s and his ongoing efforts as a finance writer and on the regulatory side through the FP Canada board focus on this initiative.   

Please let Brett know if you have any topics that you’d like him to cover in future columns by emailing him at [email protected]

The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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