TL;DR: A HELOC is a credit line that uses your home as security. It can be obtained with a lower interest rate than a regular line of credit. In Canada, the line of credit limit cannot be more than 65 percent of your property value. The amount of equity you have in your property that is greater than 20% of the value, is the amount of credit limit you may be able to get on a HELOC.

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A home equity line of credit can be a very useful financial tool. Generally speaking they are available only on owner-occupied properties. The interest rate on a HELOC is typically Prime + 0.5% to Prime + 1.00%. As of September 2019, this works out to roughly 4.45% to 4.95% - significantly less than credit cards and still quite a bit less than unsecured/personal credit lines. Here are the main features of a home equity line of credit:

Use it only as you need it

With a HELOC you do not have to use the total amount given. Rather, the idea is to use what you need so you only pay interest on the amount you have spent. With a HELOC you will be paying a daily interest rate that is a variable rate attached to a prime. 

Pay interest-only

Similar to a regular line of credit, you pay interest only on the balance of your HELOC. It is usually taken from your account once a month. If you want to pay off your HELOC principal, you will need to make extra payments over and above the interest. One of the good points of a HELOC is that you don’t have to break your mortgage, which can lead to penalty fees. 

Divide up the equity into multiple accounts or types of borrowing

Some home equity products allow the credit limit to be divided up into sub-accounts. For example if the total limit is $100,000, you may choose to allocate $50,000 to a line of credit, and $25,000 as an installment loan payable over 5 years. You may choose to leave the other $25,000 unallocated, or perhaps you decide you would like those funds available on a debit or credit card, all linked back to the sub-account on the HELOC at the HELOC rate. 

Reasons for subaccounts may include using the funds for investments, in which case you would want to tract the interest expense separately. Or you may have a large purchase coming up but you don't want to pay interest only - you'd like to pay it back in a set period of time - in which case an installment loan might be what is best for you.

Automatically increasing limit

Not all HELOCs have this feature, but many do. Suppose your property is worth $500,000, and you owe $200,000 on a mortgage already. You refinanced into a new mortgage/HELOC combination product, and you now have a $200,000 mortgage like before, and $200,000, unused line of credit. $400,000 is your total, maximum borrowing limit (80% of the value of the property).

As you pay down the $200,000 mortgage with your regularly scheduled mortgage payments, the limit on the line of credit side increases automatically.

If after 1 year, your mortgage is down to $190,000, then the available credit limit on the HELOC side becomes $210,000. This continues automatically until the HELOC hits the ceiling limit, which is 65% of the property value, or $325,000 in this example.

The automatically increasing limit is typically granted only to borrowers with very strong credit and a strong debt management position.

Perhaps the last time you need to apply for credit

Depending on where you are at in your home ownership life (starter home versus empty nest) a HELOC may be the last time you need to apply for credit. We recommend that if you are still employed and you are downsizing your home, to obtain a HELOC. When you retire, you will retain the flexibility of this product that you may not otherwise qualify for on your retirement income alone.

If you are just starting out but have managed to pull together 20% equity in a property or for a down payment, a HELOC can unlock your home equity, which may allow you to acquire investment property or use the funds for other purposes such as investing in a business or in RRSPs/TFSAs.

In either of these cases, or situations like them, a HELOC may be the last time you need to apply for credit. 

What are the downsides?

The only real downside is that if there is a still a mortgage attached, the lender may not have as much incentive to offer you a competitive renewal rate. That may make it necessary to switch the mortgage at renewal to ensure you are not overpaying interest expenses on the mortgage side of the amount owing.

It is also very tempting to pay interest only. In some cases it may be desirable or even advantageous to pay interest only. (Making that determination requires an understanding of tax law and the effect of designating properties as investment/rental properties versus a primary residence. Consult your Chartered Professional Accountant for professional advice on all tax matters.) When paying interest only, the amount due each month is lower than it would otherwise be if the debt was amortized, or scheduled to be paid off over time. Since the payment is interest only, and nothing is being paid to principle, the payment is lower. This also means that if you borrowed $100,000 and paid interest only for 3 years, you will still owe $100,000 at the end the 3 years, where you would owe substantially less had the debt been amortized.

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