What is a Home Equity Line of Credit?
A home equity line of credit is a type of revolving credit loan that allows homeowners to borrow against their current home equity. Home equity lines of credit can be great for people who want to tap into that home equity, but don’t want to take out a home equity loan or another type of second mortgage.
Both home equity loans and home equity lines of credit borrow against the equity a homeowner currently has in their home. Home equity is the amount or percentage of the home that the homeowner currently owns outright, or the portion of the mortgage that has already been paid. Home equity can easily be determined by deducting the current amount still owing on the mortgage from the total value of the home. Lenders are only allowed to loan up to 80% home equity, although most usually fall between 70% – 75%. Homeowners are also often encouraged to keep at least 50% equity in their home to ensure that they don’t owe more than their assets are worth.
The biggest difference between a home equity loan and a home equity line of credit is how the homeowner receives the money for the loan. A home equity loan works just like a first mortgage (and sometimes even is a first mortgage,) and the homeowner will receive a large sum of money upon being approved for the loan. A home equity line of credit however, works much like a credit card, with funds being withdrawn whenever needed and paid back whenever possible, with a minimum amount due each month.
Another difference between a home equity loan and a home equity line of credit is the interest rate that is attached to these two types of loans. Home equity loans are only available with fixed rates, so they may be a good option when interest rates are low, so that homeowners can lock in that low rate. Home equity lines of credit on the other hand, come with a variable rate and so will be vulnerable to shifts in the market.
Even though home equity lines of credit are revolving loans that can be used and paid back a little at a time, they are not loans that continue on forever. Generally these loans have a “draw period,” and this is essentially the end of the loan’s term. The draw period will be outlined in the initial line of credit contract and when that time comes up, the homeowner will be expected to pay back the balance that’s left on the loan at that time.
Another benefit that home equity lines of credit often bring is that the interest in them might be tax-deductible. While mortgage interest generally is not tax deductible in Canada, any money that is borrowed for investment purposes can be deducted from taxes. So if you’re going to use your home equity line of credit for renovation purposes, you’ll be putting money back into your home and therefore, using the borrowed funds for investment purposes – and getting money back in deductions too!
Bryan J is the author of this article. For more information about home equity line of credit or helocs or please visit canadianmortgagesinc.ca
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