Home Equity Lines of Credit: How Borrowing Against Your Home Works

A home equity line of credit, or HELOC, lets you borrow against your home's value, pay it back and borrow again, up to a set limit. Here is how one works day to day for BC homeowners: how much a bank can lend, how interest and minimum payments add up, what it costs to set up, and what to weigh before you use one for renovations, debt or investing.

The short version

How a HELOC works

The Financial Consumer Agency of Canada (FCAC) describes a HELOC as a revolving credit product secured by your home. You get a credit limit, draw money when you need it and pay interest only on what you have used, from the day you take it out. As you repay, the room opens up again. There are two main types:

• Combined with a mortgage. Often called a readvanceable mortgage: a regular mortgage and a line of credit from the same lender, where the room on the line grows as you pay down the mortgage principal. FCAC says you need at least 20% equity.
• Standalone. A line on its own, possibly from a different lender. Paying down a mortgage doesn't add to its limit, the rate may be higher, and you need more than 35% equity.

Either way, a lawyer or notary registers a charge on your title. Combined plans almost always use a collateral charge, usually registered for more than you borrow at the start; see Collateral Charge Mortgages.

How much you can borrow

Banks and other federally regulated lenders follow Guideline B-20 from the Office of the Superintendent of Financial Institutions (OSFI). It sets three limits against your home's value:

• 65% for the line. The revolving line of credit can't be more than 65% of your home's value.
• 80% in total. In a combined plan, the mortgage and line together can't go past 80%.
• Above 65%, it must amortize. OSFI expects any lending above 65% to be paid down on a schedule, like a mortgage, and not borrowed again. Principal you pay on that part lowers your overall limit, instead of adding room to the line, until the total is back to 65%.

For example, on a home valued at $1,000,000, a combined plan could total up to $800,000, but the $150,000 above $650,000 would have to amortize. A standalone line needs more than 35% equity, so with a $500,000 mortgage elsewhere it could be up to about $150,000. You also have to pass a stress test at a bank, FCAC notes, and the lender may ask for an appraisal. BC credit unions are regulated by the province, through BCFSA, so ask which limits a credit union applies.

How interest and payments work

Most HELOCs have a variable rate based on the lender's prime rate; FCAC's example is prime plus 1%. The rate can change when the Bank of Canada moves its policy rate, and a federally regulated lender must tell you in writing within 30 days of a change. The minimum payment may be interest only or a mix of principal and interest. As FCAC puts it, if you only pay the interest, you won't pay off your loan.

Take a $100,000 balance at an example rate of 5%, held steady unless noted:

• Interest only. About $5,000 a year, or about $417 a month. After 10 years you would have paid about $50,000 in interest and would still owe $100,000.
• If the rate rises 2 points. At 7%, the interest-only payment rises to about $583 a month.
• Paying $1,000 a month. The balance would be gone in about 10 years and 10 months, with about $29,600 in interest; at 7%, about 12 years and 7 months and about $50,500.

What it costs to set up and how it shows on your credit

FCAC lists fees you may pay for a HELOC: a home appraisal, legal fees to register the charge on your home, a title search to check for liens, administration fees and, with some lenders, monthly fees. Closing the line later can bring cancellation and discharge fees. Ask your lender which apply before you sign.

A HELOC also appears on your credit report, either as part of your mortgage or as a separate account, FCAC says. Being near or over a credit limit and applying often for new credit are among the habits that affect your score; see Your Credit Score and Your Mortgage.

Common uses, and what to check first

Among HELOC users in FCAC's survey, renovations were the most common use, followed by debt consolidation, vehicle purchases and day-to-day expenses. Each use has its own questions:

• Renovations. You can draw money as the work goes. Price the project with a contingency and decide how you will repay it. If you are buying a home that needs work, a mortgage that includes the improvements is another route; see Purchase Plus Improvements.
• Consolidating debt. Moving higher-interest balances to a line can cut the interest, but it turns unsecured debt into debt secured by your home. FCAC found that, where lenders tracked it, most HELOCs weren't fully repaid until the home was sold.
• Investing. The Canada Revenue Agency (CRA) generally lets you deduct interest on money you borrowed and used to earn investment income, such as interest and dividends, but not when the only possible return is capital gains, and not for money put into an RRSP, TFSA or FHSA. Ask an accountant first.
• A down payment on another property. Under B-20, lenders include payments on your other credit when they work out what you can afford, so the line's payment reduces what you can borrow for the second property; see Financing a Rental Property.

The risks to weigh

• Rising rates. A variable rate can go up, and with interest-only payments the whole balance is exposed. In FCAC's survey, 27% of HELOC users paid only the interest in most months or every month, and 19% of holders borrowed more than they had intended.
• The lender's terms. FCAC describes HELOCs as demand loans that a lender can recall at any time, and notes lenders may lower limits or call in loans in a severe and prolonged market correction. In its survey, only 39% of HELOC holders knew the lender could require repayment at any time. Read your agreement.
• Your home is the security. FCAC warns that if you don't pay back what you owe, your lender may take possession of your home. A collateral charge may also secure other debts you have with the same lender, depending on its terms.
• Less equity later. What you borrow comes off what you keep when you sell, and the line must be repaid then.

Switching lenders, refinancing and renewal

FCAC says you must pay off and close a HELOC before you cancel or transfer it, which usually means legal, administrative and discharge fees; ask a new lender whether it will cover any. FCAC's research also found that the mortgage part of a readvanceable plan can't easily be moved, and that a collateral charge can cost more to discharge. Some lenders don't accept collateral charge transfers at all. At renewal, compare the cost of moving everything, not just the rate; see Renewing Your Mortgage.

If you would rather borrow a set amount and pay it down on a schedule, refinancing your mortgage is the main alternative; I compare the costs in Refinancing Your Mortgage in BC.

Questions homeowners often ask me

How much can I borrow with a HELOC?

At a bank, the line itself can't be more than 65% of your home's value, and a mortgage and line combined can reach 80% only if the part above 65% is paid down on a schedule. A standalone line needs more than 35% equity, and you must pass a stress test.

Do I have to pay down the principal?

Often not. Most lenders let you pay only the interest. That keeps the payment low, but the balance stays the same, and lenders that tracked it told FCAC most lines weren't fully repaid until the home was sold.

Can my lender lower my limit or ask for the money back?

Generally, yes. FCAC describes HELOCs as demand loans that can be recalled at any time, and lenders may cut limits in a severe market correction. Check your agreement, and don't treat unused room as your only emergency fund.

Can I move my mortgage to another lender if I have a HELOC?

Yes, but the line has to be paid off and closed first, and a collateral charge may have to be discharged and a new charge registered, with legal and discharge fees to pay.

Is the interest on a HELOC tax-deductible?

Only in some cases. CRA generally allows a deduction when you borrow to earn investment income, such as interest or dividends. Money used to renovate your own home or for everyday spending isn't covered by that rule. Ask an accountant before you borrow to invest.

Weighing other ways to use your equity? Read about reverse mortgages and home equity in retirement, see how lenders work out what you can afford, or try my mortgage calculator.

This article is general information, not financial or tax advice. The details come from FCAC, OSFI's Guideline B-20 and its guidance on combined loan plans, the Canada Revenue Agency, BCFSA and a lender's published mortgage security disclosure, and were current at the time of writing; your own HELOC agreement sets out what your lender can do. For FCAC's guide, see home equity lines of credit.