Your home is likely the largest purchase you’ll ever make. Fortunately, the money you put into your home doesn’t have to stay there; it can provide financial benefits via a home equity line of credit.
Navigating the world of home finance and equity lines of credit can feel confusing at first, but it’s actually a fairly straightforward procedure for most Canadian homeowners. If you own your home, a home equity line of credit is a powerful financial tool worth understanding. Here’s what you need to know.
Home Equity 101
Home equity is the current value you own of your home. It’s the property’s market value minus the amount of any liens, typically those from the bank or lending institution which holds your mortgage. Equity is often referred to as the amount of your home that you own free and clear.
The amount of equity available to you isn’t a fixed number. Instead, it fluctuates over time according to these factors:
- Market forces affecting the value of the property
- Mortgage payments made to the lender
- Lowering the outstanding principal owed in general
The longer you own your home, and the more mortgage payments you make, the more equity accrues. Additionally, placing a down payment on your home of 20% or higher typically increases the available equity substantially.
Home Equity Line of Credit
Credit is either:
Unsecured loans require no collateral. Obtaining an unsecured loan is usually a fast process, but you do need good credit. Also, these types of loans typically have relatively high-interest rates.
Secured loans use collateral as a guarantee. In this case, the collateral is your house. Because they’re backed by physical property, secured loans typically allow you to borrow much larger amounts compared to unsecured loans.
A home equity line of credit is what’s called a “revolving” type of credit. You can borrow, repay, and borrow again up to your specific credit limit. Home equity line of credit loans are typically called HELOC loans.
Why Do People Take HELOC Loans?
HELOC loans are fairly flexible. You can borrow only the amount you need, which helps make repayment manageable because you only pay interest on the money you use.
While the money can go towards whatever you like, most people use HELOC loans for the following purposes:
- Debt consolidation
- Home improvements
Typically, home equity interest rates are lower than the rates on credit cards and personal loans. By using a HELOC loan to pay off other loan types, you can lower your monthly interest payments.
HELOC loans are a popular choice for home improvements because you’re putting the money back into your home, literally. Redesigning your floors, upgrading your kitchen, and making other improvements increase your home’s value.
How are HELOC Loan Interest Rates Calculated?
HELOC loans have variable interest rates attached to Prime. However, they’re different than variable mortgage rates. A variable mortgage rate is Prime plus or minus a number, while the interest rate on a HELOC loan is Prime plus a number.
How to Determine Your Available Equity
In Canada, the amount of the loan can’t exceed 65% of the value of the home. Additionally, the combined total of your outstanding mortgage and your HELOC loan can’t exceed 80% of your home’s value.
To determine the equity available to you, start with your home’s current market value. Multiply that number by 80%. Subtract the balance of your mortgage. That’s the maximum amount of a HELOC loan you can obtain, keeping in mind the number must be 65% or less of the total home value.
Should You Obtain a HELOC Loan?
Home equity lines of credit are a predictable, controllable way to borrow fairly substantial amounts for debt consolidation, home improvements, and more. They’re often an excellent method of utilizing your home to increase your financial freedom.