With a typical mortgage, you borrow money from a bank and that allows you to buy a home. But what if you want to get a loan and are willing to use your existing home as collateral to do so?
That’s where something called a home equity line of credit (HELOC) comes in. A HELOC is a revolving line of credit secured by your home. A revolving line of credit allows you to pay it off in full and then re-access funds without applying for new credit from your financial institution.
Canadians are permitted to borrow up to 65% of their home’s value. In simple terms, this means that if your home is worth $500,000, you can borrow $325,000 through a home equity line of credit. However, financial regulations also stipulate that your HELOC plus any existing mortgage on the home can’t exceed 80% of the home’s value. Here’s how to figure out how much you can access:
- Take the current value of your home and multiply this number by 0.8
- Next, subtract from this number the outstanding mortgage balance
- The resulting figure is what you can borrow under a HELOC, as long as it doesn’t exceed 65% of the home’s value
Going back to our example, let’s say you have a $200,000 mortgage on your $500,000 home. First, you multiply $500,000 by 80%, which equals $400,000. Next, you subtract the mortgage balance ($400,000 – $200,000 = $200,000). This leaves you with $200,000, which is also less than 65% of the home’s value.
How payments work
There are a couple things to note about HELOC payments. First, because it’s a revolving credit facility, you only pay interest on what you borrow. So even if the bank allows you to borrow $200,000, you only pay interest on the portion you have currently borrowed.
Second, payments are interest-only, unlike a typical mortgage where your payment is a blend of principal plus interest. That said, you’re still responsible for making principal payments, but it’s up to you to decide when and at what pace to do so.
Finally, the interest rate on a HELOC is usually much lower than a regular line of credit, but somewhat higher than a variable-rate mortgage. The interest rate is typically the prime rate plus a specific number (for example, prime plus 0.5%).