If you’ve built up a lot of equity in your home and want to access it today, you don’t have to sell your house.

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There are a lot of options out there that let you release some of your home equity. One of the most popular options is a Home Equity Line of Credit (HELOC).

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This guide explains everything you need to know about HELOCs – the benefits, the risks, and the alternatives. By the time you finish reading, you’ll be in a much more confident position to decide whether a HELOC is the right choice for you.

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What is a Home Equity Line of Credit (HELOC)?

A Home Equity Line of Credit (HELOC) is a type of loan that is secured against the value of your home. A HELOC helps you turn the home equity you’ve built up into cash – without having to reduce your ownership.

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HELOCs are different from most loans, which pay you a lump sum that you then repay over a period of years. Instead, a HELOC provides you with what’s called a revolving credit facility. An easy comparison is with an overdraft: you open it up with an agreed maximum limit, then dip into and repay it as you need. A HELOC isn’t exactly the same, but the basic principle is.

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For Canadians over 55, HELOCs are one of several options for funding retirement and later life plans.

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How does a HELOC work?

We want to take you through the whole process of getting a HELOC from start to finish. The more you know, the better decisions you can make.

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HELOCs are a popular product, offered by many banks and lenders in Canada. You won’t be short on options. In fact, it’s a good idea to set out your priorities from the word go.

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Do you want to borrow from your existing bank? Will you seek the lowest interest rate? Will you seek the biggest line of credit on offer? All questions you need to ask yourself and, ideally, your financial advisor. 

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The application process

Once you know which lender you want to open your HELOC with, the first step is to make your application.

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These days, most applications are done online but a lot of lenders will allow you to submit paper forms, too.

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Each lender will have their own application process, but most will need to see all your basic personal information (name, address, date of birth), proof of equity, proof of income, your existing debt (or your debt to income ratio) and your credit score.

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Approval criteria

To be approved for a HELOC in Canada, you’ll need:

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• A minimum equity of 20%
• A credit score that satisfies your lender
• To pass several checks and tests from your lender.

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We’ve written a lot more detail about the eligibility criteria for HELOCs further on in this article.

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Drawing from the line of credit

Your HELOC is structured in two periods: the draw period and the repayment period. As an example, a 30-year HELOC might have a 10 year drawdown period and a 20 year repayment period.

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You can draw from your line of credit in the drawdown period only, up to the maximum credit limit you’ve agreed with the lender. You can draw in one lump sum or bit by bit.

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Repayment process

You will have to make repayments during the draw period, but these are typically interest-only, rather than any of the original loan balance.

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When your HELOC drawdown period ends, you enter the repayment period. You can no longer take cash out and can only make repayments.

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Benefits of a Home Equity Line of Credit

A Home Equity Line of Credit is a great way to access a large sum of money. Borrowers use HELOCs to renovate their homes, fund retirement and travel plans, and for countless other reasons.

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Flexibility in borrowing

HELOCs are a hugely flexible form of credit. You don’t have a fixed monthly repayment schedule (unlike a mortgage or other loans), nor do you receive a lump sum payment off the bat. You can draw money when you need and repay as you see fit.

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The flexibility that comes with no set repayment schedule, no early repayment charges and no lump sum payments can be invaluable.

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Lower interest rates

Compared to revolving credit facilities like credit cards and overdrafts, HELOCs offer far more favorable interest rates. Using your home equity as a security makes it much less risky for the lender compared to an unsecured line of credit.

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HELOC rates, as a general rule, are a fair bit lower than most other revolving credit lines, which means your repayments and the total interest you pay will be lower.

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Potential tax benefits

The interest you pay on your HELOC can be tax deductible, but only if your loan is:

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• Generating investment income (e.g. dividends and interest).
• Functioning as a business loan (e.g. buying vehicles or equipment).
• Secured against an income-generating property (e.g. a rental).

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Speak to a tax lawyer before making any claims. You can read Income Tax Folio S3-F6-C1 if you want to do further research.

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Flexible repayment terms

Once you enter your HELOC’s repayment period, you’re committed to repaying the debt before that period ends. Technically, you could pay the entire debt back on the first or the final day of your repayment period.

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This gives you maximum flexibility, so you can use the money you’ve borrowed in multiple ways and start repayments at the best time for you.

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A quick note: the longer you wait to repay your HELOC, the more interest you will accumulate and the greater your total repayment will be.

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Revolving credit line

As a revolving credit line, you can draw funds from your HELOC whenever you need (during your draw period).

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This is a great insurance against unexpected expenses and costs. For example, if you’re using some money from your HELOC to renovate your kitchen and your contractor costs go up, you won’t need to arrange a new credit line with your lender.

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Access to large amounts of credit

With your home as collateral for the loan, a HELOC is potentially the largest line of credit you can open. Lenders can offer a HELOC up to 65% of your home’s value, giving you access to hundreds of thousands of dollars.

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It’s hard to imagine a credit card company offering the average 55 year old Canadian that kind of credit.

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Potential risks of a Home Equity Line of Credit

A Home Equity Line of Credit does come with risks, but that’s just the nature of borrowing money. There are all the usual financial risks to be aware of, as well as some that are specific to HELOCs.

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Fluctuating interest rates

HELOCs are usually variable-rate, which means the interest rate you pay can go up or down.

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If it goes down, that’s no bad thing. If they go up, you could struggle to make repayments. Your lender will have conducted a stress test to check you can afford higher repayments, but affordability and comfortability are two different things.

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Risk of foreclosure

Your HELOC is guaranteed against your home. If you can’t keep up with repayments, you risk foreclosure.

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In arranging your HELOC, you didn’t sell any of your home equity to the lender, you used your home as collateral. As a result, your home will be foreclosed upon rather than repossessed.

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Essentially, your lender doesn’t take ownership of your house but is allowed to sell it to recover the outstanding debt.

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Overborrowing and debt accumulation

It’s possible to borrow your way into trouble. If you have other debts that are taking up a lot of your income, all at variable rates or coming due in a short timeframe, you might struggle to make ends meet.

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If you lose a job or an income stream dries up, your debts could become unmanageable.

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Lenders should do their due diligence to make sure you can afford to borrow more money, but even the best checks can’t account for some unexpected scenarios.

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Fees and closing costs

Borrowing money is an expensive task and HELOCs are no different. You can expect to pay:

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• Closing costs (similar to mortgages)
• Admin fees (for arranging the loan)
• Legal fees (for the contractual work)
• Appraisal fee (to make sure your house is valued correctly)
• Discharge fee (at the end of your loan)

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Taken together, the fees involved are substantial. You’ll need to have budgeted for these, otherwise you might not be able to afford your HELOC.

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Market value fluctuations

The price of housing in Canada has, overall, been rising since the 1990s. That doesn’t mean it will continue forever – the value of your home could always decrease.

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Most HELOC agreements have a built-in buffer for this situation, given that they’ll typically only lend a maximum of 65% of your home’s value. A drop of 35% would be surprising, but it’s not unheard of – the Greater Toronto Area saw a 34% drop between 1989 and 1991.

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You’ll still owe the full debt – as well as the interest you’ve accumulated. In the worst case scenario, selling your home wouldn’t give you enough cash to fully repay your loan,

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Early repayment penalties

Most HELOCs don’t penalize you for making early repayments, but some might have this in their terms.

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Make sure you read the fine print and ask your lender directly about early repayments, so you can make a plan for repaying without incurring further costs.

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Eligibility requirements for a Home Equity Line of Credit

We mentioned approval criteria earlier in this article, but there’s a lot more to it that we haven’t discussed yet.

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Recapping from earlier, you’ll need to have at least 20% equity in your home and a credit score that meets your lender’s standards. On top of those, you’ll need to have:

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• Proof of your ability to repay (looking at your income and employment, as well as your other debts and their repayment schedules)
• A successful stress test (the lender will calculate if you can repay your HELOC at an even higher interest rate)
• Proof of home ownership and your mortgage details (if you still have one)
• A home valuation (to make sure the lender isn’t over-lending and to make sure your property is in good condition for future resale)
• Your property registered as collateral by a lawyer (notary in Quebec) or a title service company

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There are quite a few steps, but it’s all to make sure both you and your lender are protected.

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Comparing HELOC alternatives

A Home Equity Line of Credit isn’t your only option if you’re looking to leverage your property. Consider some of the options listed below, as well.

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Home equity loans

A home equity loan is secured against your home in the way a HELOC is, but it pays you a lump sum and can’t be drawn from as and when you please.

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You can get fixed rate home equity loans, whereas HELOCs almost always use variable rates. This can be preferable if rates are volatile around the time you want to borrow.

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Home equity loans  also tend to come with fixed repayment schedules, rather than an open repayment window like HELOC.

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Personal loans

If you don’t need a large sum of money, you could always take out a personal loan.

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The real benefit of a personal loan is that you aren’t using your property as collateral, risking foreclosure or repossession in the unlikely event of you defaulting.

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Reverse mortgages

A reverse mortgage lets you unlock the value built up in your home, without selling any equity. They’re secured against the value of your home, but aren’t repayable until you vacate the property.

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Reverse mortgages are what we’re all about at Bloom. Find out more about our reverse mortgages.

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Cash-out refinancing

This is the process of remortgaging your property – effectively selling it back to your lender and extending your mortgage in the process.

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If you own 80% of the equity in your home, you could sell 30% back to your lender and they’d pay you the cash equivalent.

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Your lender might limit you to a maximum percentage or time period, which could increase your monthly repayments.

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One of several options

HELOCs are popular and widely used in Canada, but they’re not the only option for taking equity out of your home.

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For some seniors, a HELOC is the perfect option – a revolving credit facility that can be used over a long period of time can be exactly what’s needed to fit their plans.

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For others, options like refinancing or a reverse mortgage can be a better fit.

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As with any major financial decision, we recommend you do your own research and talk with your financial advisor. There’s a lot to consider, but that’s a good thing. You have a lot of options ahead of you and you’ve got the luxury of choosing the right one to give you exactly what you need.

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And if you are interested in the reverse mortgage option, you can enquire about a Bloom reverse mortgage today.

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