We often receive a lot of questions and comments comparing a Home Equity Line of Credit with the CHIP Reverse Mortgage. Here is a detailed summary of what a HELOC is, its pros and cons and how it compares to the CHIP Reverse Mortgage.
What is Home Equity?
Home equity is the difference between the home’s fair market value and the outstanding balance of all liens on the property.
Home Equity Loans – There are two types of these, a fixed term loan (or conventional mortgage) and a home equity line of credit (HELOC). Both forms of home equity loans require regular interest payments. A fixed term loan or conventional mortgage has an amortization period vs. a HELOC typically has no amortization period. These loans are sometimes referred to as a second mortgage.
How does a Home Equity Line of Credit (HELOC) work in Canada?
In Canada, you must apply with a lender to find out whether you qualify for a HELOC. The more home equity you have in your home, the more you can borrow with a HELOC. In some cases, your home equity increases over time as you pay down your mortgage or as the value of your home increases.
In Canada, a HELOC can be a maximum of 65% of your home’s appraised value if you borrow from a federally regulated financial institution, such as a bank, or a maximum of 80% of your home’s appraised value at the time of closing, if your lender combines your home equity line of credit limit with the balance remaining on your mortgage. The interest rate is variable, changing as the market interest rates go up or down. The access to the money is as needed, using regular banking methods.
Administrative fees may include:
- appraisal fees
- title search fees
- title insurance fees
- legal fees
Payments: For a HELOC, the funds are available through a revolving line of credit. To pay down the balance, you have to make interest payments each month. In addition, you have the option to make minimum principal payments to help you pay down the borrowed amount.
Advantages of a HELOC:
- Access cash at a low price – Interest rates on HELOCs can be lower than for other types of loans.
- Flexible access to cash – With a mortgage, everything is fixed, but with a HELOC, once you’ve negotiated the line of credit amount, you can go up to that limit whenever you want.
- Stay in your home and keep your equity – You can continue to live in your home and maintain ownership in an asset that can go up in value.
Disadvantages Of A Home Equity Line Of Credit:
- Need to qualify – HELOCs are designed for people with sufficient income to pay at least the interest on a monthly basis. Therefore, income-strapped seniors may not qualify even if you have a lot of home equity.
- The bank can reconsider your loan – If you qualified before you retired, you may be able to borrow from the HELOC to pay the interest, however the bank can also review your credit and cut your limit at any time. They can even call the loan by asking you to repay the balance immediately, if they see that your credit is deteriorating.
- Requires monthly payments – You will need to make monthly interest-only payments, but in order to start paying down your balance, you should also make at least the minimum monthly principal payment.
- Penalties for missing payments – If you miss a payment on a HELOC, or if your spouse passes, your loan can be called. A couple may get approved for a HELOC based on the combined pension income, but if one spouse passes and pension income is reduced, it also reduces the income to pay the loan. These and other factors can jeopardize your HELOC and you may be forced to sell your home unwillingly.
- Additional fees – In order to get a HELOC, you may be required to pay appraisal fees, application fees and legal fees.
- Potential interest rate increase – Since the interest rate for a HELOC is variable, your interest will increase if the market interest rates go up.
Home Equity Line of Credit for Canadian seniors
Many Canadian homeowners have opted for a HELOC; however, is it a viable option for senior homeowners?
Many senior homeowners may or may not qualify for a HELOC because HELOCs are designed for people with sufficient income to pay at least the monthly interest. Therefore, seniors with lower or no income may not qualify. In addition, seniors may run the risk of losing their home if the bank sees them as a credit risk.
CHIP Reverse Mortgage vs. HELOC
HELOCs have more competitive rates than reverse mortgages and you can borrow up to 65% of the home’s value. In addition, you have the flexibility to take out money when you need it instead of receiving it in a lump sum or regular monthly payments. However, you have to make monthly interest-only payments and it can be harder to get qualified for the loan.
With a reverse mortgage, the interest rates are just slightly higher because you have the option of not making any regular mortgage payments on your loan until you move, sell or pass away (not even interest payments). You can borrow up to 55% of the appraised value of your home, depending on your age, property type and location of home and your income does not determine your qualification. The product is specifically for Canadian homeowners 55+.
Seniors often worry a reverse mortgage will result in nothing for the kids, but the conservative lending practices ensure there’s plenty of equity left in the estate.
Generally, whether you choose a HELOC or a reverse mortgage, tapping into your home equity is a big decision that needs to be discussed with your family. However, having the extra money in your later years, when health issues and home retrofitting are needed the most, can make a big difference in your quality of life.