What is a home equity line of credit?

Whether you're already a homeowner or looking for your first home, you may have heard of a home equity line of credit. However, do you really know what this financial product is? How does it differ from a traditional mortgage?

A home equity line of credit can be a great credit tool when used correctly. It is primarily aimed at those who are capable of managing their debts and repayments properly. Otherwise, it can have its share of disadvantages.

Home equity line of credit: what is it for?

Simply put, a home equity line of credit is a secured, revolving credit product. It is secured by your home since the financial institution uses your property as collateral to ensure that the money granted will be recovered. It is renewable, because you can use it more than once.

The line of credit is available to homeowners who hold at least 20% equity in their home or to buyers with a down payment of at least 20%. It allows them to renew their credit several times without having to re-apply. This means they can borrow, repay and borrow again, as and when they need to, until they reach the authorized limit of available funds.

Although it can represent a debt risk if not used properly, it can also represent an excellent financial asset. For example, it can help you consolidate your debts by combining them into a single debt at a lower rate. It can also be of great help in its function as an emergency fund to cover any unforeseen costs.

You can obtain a mortgage line of credit when you apply for financing or when you renew your mortgage.

Buying a home with a home equity line of credit

It is possible to finance the purchase of a home with a mortgage line of credit, subject to certain conditions. Amongst other conditions, the minimum down payment required by financial institutions is much higher than that required for a traditional insured mortgage.

Home equity line of credit combined with a mortgage

Home equity lines of credit are mainly used by large financial institutions in combination with a mortgage. With this combination, you can finance up to 80% of the value of the property.  However, the maximum financing limit for the line of credit itself is 65% of the purchase price or market value of the property.

To obtain it for the purchase of a home, you will need to have equity in your property (if you already own it) or a minimum down payment of 20%. Since it cannot represent more than 65% of the market value, any remaining proportion must be financed with a mortgage.

For example:

You buy a $350,000 home with a down payment of $70,000 (20%). The balance of your mortgage financing will be $280,000. The limit on your line of credit will be $227,500, or 65% of the purchase price. You would therefore need to take out a minimum loan of $52,500 ($280,000 - $227,500) to cover the remaining 15%.

Part of your purchase will thus be financed by a line of credit and the other part by a conventional mortgage. You and your lender can work out how each part will be used to finance your property purchase.

With this type of financing, the funds from your line of credit will be available when you pay off your mortgage. The greater the proportion repaid, the greater the amount of credit available, until the 65% limit is reached. However, you will not have access to the repaid funds for the loan part.

In terms of payment, only the interest is generally payable by the financial institution for the line of credit part. For the mortgage part, repayment is made according to the terms of the contract signed between the borrower and the financial institution.

Independent home equity line of credit

This financial product can also be offered independently by certain financial institutions. It can be used as an alternative to a traditional mortgage.

Like a mortgage loan, an independent home equity line of credit allows you to finance up to 65% of the value of your home. To qualify for financing, you must have a down payment (or equity in your property) of at least 35% of the market value.

The repayment terms are much more flexible than those for a traditional loan. Only interest is payable. You can decide how much you want to pay and how often. You can even choose to repay the balance in full, without incurring any early repayment penalties.

The capital repaid on your line of credit is automatically available to help you carry out your plans or deal with unforeseen financial circumstances.

Eligibility requirements

If you wish to obtain a mortgage line of credit, whether independent or associated with a loan, you will have to show the financial institution that you are eligible. You will therefore need to have:

• A down payment or home equity of at least 20% (if associated with a mortgage);
• A down payment or equity in your property of at least 35% (if independent);
• A good credit history;
• Proof of stable and sufficient income.

If you are already a homeowner and want to use the equity in your home to obtain a home equity line of credit, you will also need to:

• Prove that you are the owner of your home;
• Provide details of the mortgage you have previously taken out (balance, term, amortization, etc.);
• Have your property valued (the lender usually hires an appraiser itself).

Prior to granting you the finance you require, the financial institution will consider your level of indebtedness to ensure that it is acceptable. You will also undergo a stress test to check your ability to repay at a higher rate than that specified in your contract.

The advantages and disadvantages of obtaining a home equity line of credit

Are you interested in a home equity line of credit, but are unsure whether it's really the right solution for you? Here's a summary of some of the advantages and disadvantages of obtaining this financial product.

The advantages:

• It facilitates access to credit;
• It makes it easier to carry out any plans (renovations, buying another home, etc.);
• It allows you to consolidate your debts at a lower interest rate;
• It only requires the payment of interest on the sum borrowed;
• It allows greater flexibility in borrowing and repayment;
• There are no penalties in the event of early repayment.

The disadvantages:

• You need discipline to pay the amount borrowed;
• If misused, it facilitates indebtedness;
• It can complicate the transfer from one lender to another by requiring full repayment of the line of credit and related credit products;
• In the event of non-payment, the financial institution can take possession of your home.

A home equity line of credit can seem complex. It is therefore essential to seek advice from experts in the field to determine whether this is the right financial product for you.

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