Wednesday, September 20th, 2017

Understanding a home equity line of credit

A home equity line of credit (HELOC) is a mortgage with extra options included.  If you have at least 25% equity in your house you might want to consider using one.  A HELOC is a debt with a fixed credit limit within which you can hold multiple accounts such as a mortgage, loan, car loan, credit card, renovation loan or whatever.  Each section of the HELOC has its own separate account number but the total debt on all accounts cannot exceed the overall HELOC credit limit.
For example, imagine you bought a home for $150,000 six years ago and the current mortgage balance is $100,000 at a rate of 6%.  You also have a car loan of $10,000 at 7% and an unsecured line of credit balance of $5,000 at 8%.  Today the home may be worth $200,000.  If you ask for a line of credit the bank can lend up to 75% of the home’s market value.
$200,000 x 75% = $150,000 HELOC maximum
Your new secured HELOC could look like this:
previous mortgage                $80,000
car loan                                $10,000
previous unsecured LOC        $5,000
available for use                    $55,000
Total secured LOC              $150,000
1. You don’t have to keep everything separately, but it can be useful for clarity.  You have a single statement showing all debt.
2. The interest rate on the car loan and LOC would decrease to prime, saving you money and always being available for future use without an application to the bank.
3. The mortgage term can be fixed or left floating as a HELOC.  You can break the mortgage portion into different part with different term if you wish.
4. As debt is reduced your borrowing limit on the “available for use” section increases, meaning you can always get your money back instantly if and when you need it.
5. The “available” section can be used to top up your RRSP limit or invest* outside RRSP’s, likely generating a tax deduction.
6. If you use the floating rate option you can pay as little as interest-only.  In times of a cash flow crunch this can avoid late or missed payments.

 *Borrowing to invest is not suitable for everyone. You should be fully aware of the risks and benefits associated with using borrowed money to invest since losses as well as gains may be magnified.