What is a home equity line of credit (HELOC)?

If you’re a homeowner with at least 35% of equity in your home, you might be eligible for a home equity line of credit, or HELOC. A HELOC allows you to tap into your home’s equity to borrow cash against your primary residence. This can often be a more affordable option than taking out a second mortgage, personal loan, or construction loan. But a HELOC won’t be the right solution for everyone.

Here’s everything you need to know about home equity lines of credit to decide if it’s the right move for your financial goals.

What is Home Equity and A Home Secured Line of Credit?

Your home’s equity refers to the amount of your property that you own. For example, if your home is worth $500,000 and you have $200,000 remaining on your mortgage, you own 60% of your home and have $300,000 in equity.

A home equity line of credit lets you draw on the equity you’ve built up in your home. A HELOC is a revolving credit account, similar to a credit card. You’re approved for a set amount — usually up to 65% of your home’s value — and you can draw from this revolving line as you need.

HELOCs have a draw period that lasts between 5 and 15 years, during which you can pull from your line of credit. During this time, you’re only required to pay the interest on any funds you borrow. After the draw period ends, your repayment period begins, and you’ll start paying back the funds you accessed monthly.

A HELOC can be helpful if you’re renovating your home or starting a project with an unclear budget and timeline, since you can access cash as you need it. If you have a set amount you need to borrow, a home equity loan might make more sense.

While home equity lines of credit have high rates right now, these rates are often lower than alternative financing options, like personal loans. And, having a line of credit available in case of an emergency — even if you never pull from it — could be helpful.

But there’s a serious risk to consider before taking out a HELOC. Home equity loans and lines of credit are secured loans. A secured loan requires a type of collateral in exchange for financing. In the case of a HELOC, your house serves as the collateral. So if you’re unable to repay any funds you borrow, you could lose your home.

Pros and Cons Home Equity Line of Credit (HELOC)?

Before applying for a HELOC, weigh the pros and cons to determine if this borrowing option is right for you.

Pros:

• More affordable than credit cards and personal loans. HELOC rates start above 7%, which is high, but more affordable than other options. Credit card APRs range from 19.99% to over 25% right now, while personal loan interest rates can go over 46%, depending on your credit score.

• Tax-deductible interest. You can deduct the interest you pay on your HELOC from your tax returns each year.

• Flexibility. The main benefit of a HELOC over a home equity loan is that you have a more flexible timeline and amount available to you. This can be ideal for projects without a set budget.

• Lower credit score requirements. Depending on the lender, you may be able to get approved for a HELOC with a credit score as low as 620, which is lower than the 680 credit score requirement you’d need for a mortgage.

• Emergency access to money. Even if you don’t have a need for a line of credit right now, having a HELOC available to you can come in handy if an emergency expense pops up.

Cons:

• You could lose your home. If you miss HELOC payments or you’re unable to repay the amount you borrow, you could lose your home. It’s a serious risk to consider before applying for a HELOC.

• You’ll have less equity in your home. If property values go down, you may find yourself owning more money on your home than it’s worth.

• Variable interest rates. Most HELOCs have variable interest rates, which means the rate changes based on economic conditions. That can make your monthly payments unpredictable, and potentially unaffordable some months.

• Easier to overspend. When you take out a loan, you have a set amount that you borrow and fixed interest rate, which makes it easy to plan for repayments. But since a HELOC potentially gives you access to hundreds of thousands of dollars, you might be more inclined to overspend — which can leave you with a hefty bill to repay.

How does a HELOC work in Canada?

If you’re interested in applying for a HELOC in Canada, you’ll want to make sure you own at least 35% of equity in your home. You’ll also need at least a 620 credit score, though some lenders might require a higher credit score. It’s a good idea to shoot for a higher score, since you’re more likely to get approved at a lower rate this way.

You can boost your credit score by working on paying down debt, making sure you pay your credit card bills on-time and in full each month, and keeping your credit utilization rate under 30%. That means if you have a credit card with a $5,000 limit, spending less than $1,500 on your card in total each month.

Once you’re ready to apply for a HELOC, shop rates from different lenders to find the best fit. Once you’ve pared down your options, apply for the lender that offers you the best rate and other perks. If you’re approved, you’ll typically receive your funds in a matter of days.