What Is A HELOC And How Does It Work?

As the name suggests, a home equity line of credit (HELOC) lets you borrow against the equity in your home. A HELOC may be tied to a conventional mortgage or a standalone personal loan. Similar to a credit line, a HELOC is revolving credit, so you can withdraw money from it, pay it back and then draw it down again without having to requalify.

You can apply for a HELOC when:

• You purchase a home and apply for a new mortgage loan.
• You refinance your mortgage.
• You renew your mortgage.

While home equity lines of credit have been available in Canada since the late 1970s, HELOCs grew in popularity during the 2000s, driven by lower interest rates and rising house prices. In fact, HELOC balances increased from $35 billion in 2000 to $186 billion by 2010, an annual growth rate of 20%, according to the  Financial Consumer Agency of Canada (FCAC).

According to the Canada Mortgage and Housing Corporation, Canadians owed $212 billion in HELOC debt as of the end of 2023, compared to $58 billion in lines of credit and $119 billion in credit card debt. This was a 5.7% increase over 2020. Homeowners in Toronto held the largest share of that debt, at over $50 billion, followed by Montreal at $25.5 billion and Vancouver at $23.4 billion. For context, outstanding mortgages totalled over $1.8 trillion dollars.

In 2022, the Office of the Superintendent of Financial Institutions implemented new guidelines for HELOCs (as well as other real estate loans that are paired with revolving credit lines), that limit the amount that a homeowner can borrow to 65% of the underlying home’s value, down from 80%. At that time, HELOCs (referred to as “Combined Loan Plans”) that were above this 65% loan-to-loan ratio accounted for $204 billion of the $1.8 trillion in outstanding residential mortgages, according to the Bank of Canada.

This means you can borrow up to 65% of your home’s purchase price or appraised value. So if you own your home and it’s currently valued at $650,000, you can borrow up to $422,500. However, if you have a mortgage on the property, your mortgage and your HELOC’s combined value can not exceed 80% of your property’s value, also known as the cumulative loan-to-value ratio. Put differently, you can finance up to 80% of your home’s purchase price or market value, but the value above 65% must be on a fixed-term mortgage.

Here are some examples of how this works assuming a $650,000 home:

(i) In this instance, using the ((home value x 80%) – mortgage balance) calculation, you could borrow up to $470,000 of your home’s value. However, due to OSFI rules, the maximum amount you can borrow with the revolving credit line is up to 65% of your home’s value. The balance must be on a fixed-term mortgage.
(ii) The maximum amount you can borrow with the revolving credit line is 65% of your home’s value, or $422,500.

To see if you qualify for a HELOC, Forbes Advisor Canada has a useful HELOC calculator here.

Keep in mind that non-federally regulated lenders, such as provincial credit unions, may use criteria other than the 65% maximum to determine your HELOC limit. Moreover, some lenders may have a minimum amount you can borrow. For example, CIBC’s Home Power Plan has a minimum borrowing amount of $10,000, while BMO has a $5,000 minimum limit.

There are two main kinds of HELOC available in Canada. Due to the competitive nature of mortgage products, the specifics may vary between lenders:

HELOC Combined with a Mortgage

Also known as a readvanceable mortgage, this type of HELOC combines a conventional fixed-term mortgage with a revolving line of credit. As you pay down your mortgage, the credit limit also increases as the amount of credit you can qualify for is linked to the equity in your home. As noted above, your mortgage and HELOC’s combined value may not exceed 80% of the property’s value, and the credit limit can be a maximum of 65% of your home’s purchase price or market value.

For example, if you purchase a home for $400,000, to get a HELOC you need a minimum 20% down payment, or $80,000, leaving a mortgage balance of $320,000 (not including mortgage default insurance). The maximum you can finance with a HELOC is $260,000 ($400,000 x 65%). The mortgage balance of $60,000 ($320,000 – $260,000) must be financed with a conventional fixed-term mortgage with regular payments and an amortization period.

Standalone HELOC

In this case, you can get a HELOC without a mortgage loan. Due to the OSFI rules, the maximum amount you can access as revolving credit is 65% of your home’s value. You make interest-only payments on the amount used, giving homeowners more flexibility. However, if you’re not disciplined with your repayment plan, this strategy can cost you a lot in interest over the life of the HELOC.

Some examples of HELOC products currently offered by the Big Six Banks include:

• BMO Homeowner ReadiLine
• CIBC Home Power Plan Line of Credit/CIBC Home Power Plan
• RBC Homeline Plan
• Scotiabank Total Equity Plan (STEP)
• TD Home Equity FlexLine
• National Bank of Canada All-In-One Home Equity Line

Why Do People Take Out a HELOC?

Since a HELOC is a flexible loan, some of the common uses for a HELOC include:

• Home renovations or repair
• Debt consolidation
• A down payment on an investment property or second home
• Paying down or paying out a mortgage
• As an alternative to a traditional mortgage

You could also use the funds from a HELOC to cover a large expense, such as post-secondary tuition or a wedding. Some homeowners use a HELOC to build their investment portfolio, however, depending on the type of investment account, you’ll need to pay tax on any non-registered income or capital gains.

Similar to a mortgage, rates for a HELOC vary between financial institutions, but in general, they use a variable interest rate, typically prime plus a premium of between 0.5% and 2%.

There are also fees associated with a HELOC, such as:

HELOC Vs. Reverse Mortgage

If you’re 55 or older, a reverse mortgage allows you to borrow a percentage of the current value of your home to get tax-free cash. You don’t make monthly loan payments, but repay the loan (plus accrued interest) when you sell your house. It can have a fixed rate or variable rate.

HELOC Vs. Home Equity Loan

Unlike a HELOC, which has a variable interest rate on a revolving loan, a home equity loan is a fixed-rate loan where you receive a lump sum of cash that you repay in installments of principal and interest. A home equity loan may also be called a second mortgage, and interest rates, which may be fixed or variable, are typically higher because a second mortgage is considered a higher risk.

HELOC Vs. Home Equity Sharing Agreement

Toronto-based Clay Financial is now offering a home equity sharing agreement (HESA) that gives homeowners in the GTA a lump-sum, tax-free cash payment, of up to 17.5% (or $500,000) of their home’s value. There are no monthly payments of either principal or interest, but when you sell your home you repay the advanced amount, plus the company’s share of the appreciation of your home at a rate of four times your home’s value at assessment.

HELOC Vs. Secured Personal Line of Credit

With a personal line of credit, you can borrow up to a preset limit on a revolving basis. You pay interest on the money you borrow, which is usually at a variable rate. A line of credit can be secured or unsecured. With a secured loan, you can use the equity in your home (or an investment portfolio) as collateral, and you can typically get a higher credit limit than you can with an unsecured loan.

HELOC Vs. Mortgage Refinance

When you refinance your home, you’re replacing an existing mortgage with a new one, up to 80% of the home’s value. A refinance is a way to access existing equity in your home without selling. You can access up to 80% of your home’s current value, less your outstanding mortgage. This difference can be paid out in cash, and then you are responsible for making mortgage payments on the total loan amount.

Here is a breakdown of the main differences between loan products:

HELOCs are readily available at banks (including the Big Six and online banks, such as Tangerine and Motusbank), credit unions, and other financial institutions. However, not all lenders offer both a combined HELOC and a standalone HELOC.

Similar to a mortgage, each lender has its own qualification standards, including:

• Proof of sufficient income
• A good credit score (at least 680 or above will get you the best rates)
• A manageable debt-to-income ratio (the percentage varies by lender)
• Sufficient equity in, or down payment for, your home

You’ll also need proof that you own your home and details of your current mortgage.

You can access a HELOC through online banking, your bank’s app and an ATM. Your lender may also provide you with cheques. Remember that interest starts accruing when you withdraw funds from your HELOC.

Unlike a mortgage with regular principal and interest payments, a HELOC only requires monthly interest payments. According to the FCAC, most HELOCs in Canada have indefinite terms. You can make additional principal payments when you like. Typically, your HELOC remains open until you sell your home or otherwise decide to pay off the balance in full.

However, your lender may have other repayment options. For example, with Desjardins Financial you can create a tied loan to your HELOC where you repay your loan on a fixed rate and specified term.

Pros

• You can access the equity in your home without selling your home.
• There are no restrictions on how you use the funds in a HELOC.
• You can access as much of the HELOC as you want (up to your credit limit) and only pay interest on the amount used.
• The interest rate for a HELOC is lower than an unsecured credit line or credit card, which averages 19.99% to 20.99%.
• You can easily access funds from your HELOC through your bank card, cheques or online banking.
• As a HELOC is a revolving line of credit, you can access additional funds as you pay down the balance owed without having to requalify for a new loan.
• If you have a mortgage loan and line of credit, you can choose interest-only payments on the line of credit portion.
• Unlike a mortgage, you can pay off the entire balance without any prepayment penalties.
• You typically don’t need to repay your HELOC until you sell your home.
• Depending on your home equity, you may be able to qualify for a higher credit limit than you would with another credit product, such as a regular credit line.

Cons

• Rising interest rates can affect the cost of your loan. As your HELOC uses a variable interest rate (prime plus a number), when interest rates go up, so do your payments.
• The interest rate on a HELOC is likely higher than a variable mortgage rate. For example, a standalone HELOC with National Bank is prime plus 1%, or 8.2%, while a 5-year variable rate mortgage is currently prime minus 0.25%, or 6.95%.
• Your home is collateral for the debt. If your financial situation changes and you can no longer service the HELOC debt, you could lose your home to your lender.
• A HELOC is a callable loan. This means your bank can legally demand your entire balance owed at any time, even if you have not missed payments or otherwise gone into default. But if you lose your job and your lender now rates you as higher risk, theoretically, you may need to repay your entire loan.
• With a combined mortgage, you need a minimum of 20% equity in your home, or a down payment of at least 20% when buying a new property. Your mortgage can not be insured.
• The ease of accessing a HELOC can make it easy to overspend.
• As the loan is open and not amortized, interest-only payments can erode wealth over time.
• With a readvanceable mortgage or combined HELOC, you’ll likely have to repay your HELOC in full if you want to switch lenders at renewal time.
• Unlike a credit card that gives a grace period, HELOC interest starts accruing immediately each day.

When used responsibly, a HELOC can help homeowners access funds at a competitive interest rate to increase the value of their home through renovations, improve their individual earning potential through education and training or increase their monthly cash flow through debt consolidation. However, the flexibility of these products can be costly in the long run without a disciplined approach to spending and repayment.