How does home equity line of credit work?

14 August 2023 by National Bank

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A home equity line of credit (HELOC) gives you access to funds that you can use to finance your projects. Here’s an overview of what you need to know to make the most of this solution.

In this article:

What is a home equity line of credit?
Who can take advantage of a home equity line of credit?
How do you use a line of credit?
What are the advantages of a home equity line of credit?
Can you use a home equity line of credit for tax optimization?
What are the risks of using a home equity line of credit?

What is a home equity line of credit?

A home equity line of credit lets you borrow against the equity in your property. It gives you access to a portion of the repaid principal of your mortgage loan. Over the years, you can reuse the portion of your repaid principal that’ll be reallocated to you for different projects.

In other words, you can keep reborrowing a portion of the payments you make on your home.

HELOCs are often combined with “conventional” mortgage financing (i.e., loans without mortgage loan insurance offered by providers like CMHC). This means that you need a down payment of at least 20% of your home’s sale price.

Important: Credit approval is required to obtain a home equity line of credit and the revolving credit cannot exceed 65% of your home’s purchase price or market value.

Example: You purchase a home for $450,000 with a 20% down payment ($90,000). Your mortgage balance is $360,000 ($450,000 - $90,000). The revolving credit limit on your HELOC is 65% of the purchase price of the house: $292,500 (65% of $450,000).

You can use a HELOC to access funds without having to apply for credit again. You could use it to:

Wondering whether paying down your mortgage faster is a good idea?
→ Read our article about accelerating your mortgage payments

Who can take advantage of a home equity line of credit?

A HELOC is available to:

People who already own a home and already have a mortgage
People who are about to buy a property and don’t yet have a mortgage

You can apply for one:

When you apply for a new mortgage loan
When you refinance your mortgage
When you renew your mortgage

Are you getting ready to buy a new home?
→ Read our article: 7 steps to buying your first home

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Good to know: You may be required to pay legal and property appraisal fees.

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Did you know?

It’s possible to get a home equity line of credit without a mortgage loan. If you have a down payment equivalent to at least 35% of your home’s purchase price, the remaining 65% can be financed using a home equity line of credit. This means that the borrowing to finance your property would be entirely covered by the HELOC rather than by a mortgage loan.

This can be a useful strategy, as the terms of repayment for lines of credit are often more flexible than for mortgage loans.

How do you use a line of credit?

Using a line of credit is similar to using a bank account. You can access it via online banking, your current account or at an ABM and carry out multiple types of transactions, including one-off or regular withdrawals and deposits (transfers, bill payments, etc.).

At a minimum, it’s important to pay the monthly interest on the balance used. The best way to do this is to set up a regular payment from your bank account.

Simplify the management of your line of credit

Some financial institutions allow you to separate your HELOC into several bank accounts. You can have your salary deposited into the account, make withdrawals from it using a debit card, etc. The aim is to make it easier to keep track of the funds you’ve borrowed and repaid for different needs.

What are the advantages of a home equity line of credit?

A HELOC allows you to borrow up to 65% of the value of your home while benefiting from flexible repayment terms. It’s a way to:

Tap into your home equity to easily access significant liquidity
Avoid making multiple applications for credit
Benefit from attractive interest rates

Can you use a home equity line of credit for tax optimization?

Self-employed workers and owners of businesses or rental properties can use a line of credit as part of a cash damming strategy.

The objective is to convert interest that is not tax deductible (such as interest on a residential mortgage) into interest that is tax deductible. It’s a way of converting loan interest into business expenses and thereby optimizing the tax you pay.

→ Explore the benefits of our home equity line of credit

Another strategy involves using your home equity line of credit to invest. In certain circumstances, depending on the type of investment chosen, the interest will be tax deductible.

For more details on this strategy:
→ Read our article about claiming interest expenses and carrying charges.

What are the risks of using a home equity line of credit?

There are two main types of risks associated with using a home equity line of credit:

Since the interest rate is variable, the amount of your repayments can go up. That said, there are some ways to avoid this risk. Some financial institutions even allow you to protect your interest rate.
Because a HELOC makes it easy to access funds, using this solution unwisely can lead to debts and deplete assets.

There are a few ways to reduce the risks:

Set up regular transfers from your bank account to your line of credit to ensure that interest is paid in a timely fashion.
Limit your access to the line of credit (e.g., avoid linking it to a debit card so that it can’t be used too easily.)
Sign up for online banking so that you can manage your line of credit and monitor the balance and your transactions on a regular basis.
Protect your repayments with loan insurance.

Home equity lines of credit can offer many benefits. It all depends on your financial situation and needs. Talk to our team of experts to apply for a home equity line of credit and ensure you understand all the pros and cons of this solution.

Would you like to discuss this with us? Contact your National Bank advisor or your wealth advisor at National Bank Financial. Don't have an advisor?

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The information in this article is provided for illustration purposes only and is not exhaustive. For advice on your finances and to determine whether the features described in this article are right for you, please speak with your National Bank advisor or, if applicable, a professional (accountant, tax expert, lawyer, notary, real-estate broker, etc.).

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