HELOC - Home Equity Line of Credit

HELOC is short for Home Equity Line of Credit, also known as Home Equity Line. HELOC is a special type of credit line, secured by the equity in the borrower's home. With the home equity line of credit the lender sets a maximum amount that the borrower can draw, and the entire amount of the loan is not advanced in contrast with regular loans. HELOC is not to be confused with Home Equity Loan, in which the borrower receives the entire amount of the loan upfront.

HELOC "Draw" and "Repayment" Periods

When you are approved for a HELOC, there are two important periods associated with it, which you need to be aware of. The first Home Equity Line of Credit period is the so-called “draw period”, during which you can borrow on your credit line. During the “draw” HELOC period you can borrow any amount up to the HELOC credit limit at any time. HELOW draw periods usually last between 5 and 15 years and during this time the borrower is required to pay only interest on the borrowed amount. The borrower may repay the borrowed amount in part or in full during the draw period, without any penalties.

There are two things that can happen at the end of the draw period. First depending on the HELOC the lender might require repayment of the loan in full, which means that the homeowner has to refinance at that time. The second option is entering the HELOC “repayment” period, in which case the borrower has to start repaying the loan principal as well.

HELOC Interest

The interest rate on a home equity line of credit is calculated daily, similarly to credit cards. HELOC interest rate is always adjustable, and in essence a HELOC is Adjustable Rate Mortgage. The interest rate of a home equity loan is usually tied to financial index and most HELOCs use the Prime Rate as their index. The lender will set certain margin at the time of the HELOC approval, and the interest you will be paying will be Prime Rate plus this margin. For example if the lender sets a margin of 2% for your HELOC, and the Prime Rate is 6% then you will be paying 8% in total interest. Some lenders offer HELOC introductory interest rates, which are locked for a short period (usually no more than a few months), but after that the interest will move with the index it is tied to.

Are HELOCs risky?

The short answer is yes, the HELOCs are risky. The main risk comes from the interest rate fluctuations, and the fact that the changes in the Prime Rate are almost immediately reflected in the home equity line of credit interest rate, affecting your mortgage payments. Even though HELOCs are adjustable rate mortgages by nature there are several important differences making them riskier. You can lock the initial interest rate of ARM for as many as 10 years, while you can't do that with a HELOC. Most of the adjustable rate mortgages have interest rate adjustment caps, which limits the interest rate risk for the borrower, while the home equity lines of credit don't have adjustment caps. You should be aware that HELOC charge yearly fee, no matter if you have borrowed something on the credit line or not.

Home Equity Line of Credit Advantages

The most important advantage of a HELOC is the fact that you pay interest only on what you actually borrow. Another HELOC advantage is the relatively low costs compared to traditional mortgages. Another positive thing about HELOC is the repayment flexibility they offer.

In conclusion all major Canadian banks and some other Canadian financial institutions offer home equity lines of credit, making this financial product easily accessible for Canadians.