How does a home equity line of credit work?

When financing renovations or dealing with an urgent problem, a home equity line of credit or mortgage refinancing is often a better option than withdrawing RRSP funds. Browse this article to find out more and make the best decision.

What is a home equity line of credit?

A home equity line of credit is a secured form of credit that uses one property as a guarantee to finance other projects. It is generally available to homeowners with a conventional mortgage whose down payment was above 20% of the purchase price.[1]

The credit limit on a home equity line of credit can be a maximum of 65% of the purchase price or the market value of the house.[2] The amount of credit available will increase as you pay down the principal on your mortgage.

Mortgage refinancing does not require paying off the principal and interest on a fixed payment schedule, as only the interest charged on amounts borrowed are mandatory. This is an open mortgage that can be repaid in part or in full at your convenience. However, to qualify, you will have to meet various conditions and undergo a mortgage stress test.

How do you use this type of financing?

Unlike a conventional loan, a home equity line of credit can be used like a bank account, even if the mortgage has been paid off in full.

In some cases, it can be combined with a fixed term mortgage to finance a new property. The minimum down payment or net worth of the house must then be at least 20% and the line of credit used must not exceed 65% of the purchase price or market value of the house.[3]

Benefits of mortgage refinancing

Though a home equity line of credit usually has a higher interest rate than a conventional mortgage, it is often more advantageous than most personal loans.[4] This is why some people choose to use it to:

• Buy a car
• Renovate their home
• Purchase a secondary residence
• Maximize RRSPs

Disadvantages of a home equity line of credit

However, mortgage refinancing carries certain risks:[5]

• Because only monthly interest payments are required, more self-discipline is necessary.
• The chances of incurring debt are higher because cash is readily available.
• Repayment of a home equity line of credit in full may be claimed before the mortgage is transferred to another bank or financial institution.
• In the event of non-payment, the property may be repossessed.

Are you interested in refinancing your mortgage to carry out your projects? First assess your credit requirements and make sure you have a detailed plan of how you intend to use them. This will allow you to get the most out of the benefits available to you while minimizing risk.

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See also:

How do you pay off your mortgage faster?

How a good credit score can get you on the property ladder

How do I take advantage of FHSA when buying a first home?