HOME EQUITY LINE OF CREDIT
HELOC or Home Equity Loan
There are two types of home equity loans, a fixed-rate loan and a home equity line of credit (HELOC) which is a revolving line of credit. Both are secured against the equity built up in your home and are offered by different types of lenders – banks and home equity lenders. HELOC or Home Equity Loans allow you to access your home equity which is the difference between your home value and your mortgage balance as collateral.
1. As your home appreciates in value, and
2. As you pay down your mortgage principal
Lenders will require an appraisal to determine the value of the home. You can use the proceeds of the loan for home renovation, debt consolidation, and pay off credit cards to help increase your credit score.
Home Equity Line of credit (HELOC)
A HELOC is considered a second mortgage that differs from a traditional mortgage and is similar to a credit card in that the entire loan isn’t advanced the loan upfront but you use the line of credit to access funds to the allowable limit. Like a credit card you can access what you have repaid thus the name revolving line of credit. Your repayment amount is your withdrawal amount plus interest or minimum interest-only payment amount like a credit card. You can make payments of principal and interest at any time without penalty. The maximum loan-to-value for a HELOC is 65% of the value of your home.
HELOCs must be repaid in full within a certain period (usually 25 years of amortization). For example, you may be able to pay the interest-only payments for the first 10 years and then pay the principal in the final 15 years. Because there is no regular payment of principal and interest, it is unknown what the balance will be at any time during the mortgage so after the tenth year you would have to make balloon payments to pay off the mortgage by the end of the amortization as per your amortization schedule.
In addition to being able to access the money, you have paid back. Another important difference with a HELOC is that the rate is variable and tied to your bank’s prime rate and can change up or down depending on the rate set by the Bank of Canada.
HELOCs are popular among homeowners because of their flexibility, both in terms of borrowing and repaying on a schedule determined by the borrower. Furthermore, HELOC loans’ popularity may also stem from their having a better image than a “second mortgage,” a term that can more directly imply an undesirable level of debt. However, within the lending industry itself, a HELOC is categorized as a second mortgage.
Fixed Rate Home Equity Loan
With the fixed-rate home equity loan in which the borrower uses his or her home equity to get a loan using the home as collateral. The amount of the loan is determined after an appraisal is done to arrive at a value. The loan amount is a percentage of the value less any outstanding mortgage. The maximum amount ranges from 65% to 80% for first mortgages and up to 85% for second mortgages.
Home Equity Loans rates are higher than those of home Equity Lines of Credit but are much lower than credit card interest payments, so they are a great option to consolidate credit card debt and save money.
Home Equity Loans are usually offered by non-bank (private) lenders are offered at higher interest rates. Borrowers who don’t qualify for a HELOC because of insufficient income could qualify for a home equity loan. Only your home equity is required to qualify, and rates are dependent on the loan value. Income and credit aren’t considered. Unlike a HELOC, with a home equity loan, the lender advances a single lump sum for a set term (usually one year). At the end of the term (maturity) the loan is paid back in full or renewed for another term. The rate is usually the same and there is a lender who charges a renewal fee.
Payment can be interest only or a blend of principal and interest are made monthly, and there are no options for prepayment prior to the mortgage maturity date without a penalty. Home Equity loans usually have a three months interest penalty if you want to repay the mortgage before maturity.