The main difference between a HELOC and a Mortgage is that a HELOC allows you to borrow and repay funds continuously as needed up to a pre-set credit limit.
On the other hand, a mortgage provides you with a lump sum of money upfront, which you must repay according to a predetermined schedule.
Any principal you pay back is no longer available for you to borrow again.
Below is an overview of the primary features of HELOCs and mortgages.
|Interest rate||High, only variable rates are available||Low, fixed and variable rates are available|
|Maximum loan-to-value (LTV) ratio||Borrow up to 65% as a stand-alone product and up to 80% if combined with your mortgage||Borrow up to 80% for a conventional mortgage and 95% for a non-conventional mortgage|
|Payment Schedule||Flexible – minimum payments to cover interest charges are required, but borrowers’ can tailor their payment size and frequency; prepayments are allowed and incur no financial penalty||Rigid – payments consisting of interest and principal are required at fixed intervals for the loan term; prepayments are allowed but may trigger a financial penalty|
|Amortization schedule||None – there’s no maturity date||25 years maximum for a conventional mortgage; 35 years for a non-conventional mortgage|
What is a HELOC?
A Home Equity Line of Credit, or HELOC, is a revolving loan product that provides access to funds that you can borrow at your discretion up to a predefined credit limit.
You can use a HELOC to help cover the cost of a wide range of expenses and investments such as a home renovation, post-secondary education, and a vacation.
You can even substitute a HELOC for a mortgage to finance a home purchase.
A HELOC cannot exceed 65% of your property’s value if you acquire it as a stand-alone product.
If you combine it with your mortgage, the maximum amount you can borrow is 80% of your property’s value.
A HELOC offers a much more affordable interest rate than a personal line of credit because your home secures your outstanding balance.
This means that your lender has the legal right to take possession of your property and sell it to cover the principal should you default on your payments.
This layer of protection drastically reduces the risk they assume in extending credit to you, which is why rates on HELOCs are so low.
A HELOC generally only comes with a variable interest rate.
As a result, you can expect your interest charges to fluctuate based on changes in your lender’s prime rate.
HELOCs offer flexible repayment terms.
You have ample freedom to customize your payment schedule according to your household’s cash flow and budget.
You also can repay the entire principal at any time without incurring a prepayment penalty.
In general, most lenders require that at a minimum you pay interest component of your outstanding balance each month.
After an extended period, you may be required to cover the principal in addition to the interest.
Did You Know
Although HELOCs come with variable interest rates, some lenders allow you to convert a portion of your balance into a fixed interest rate loan.
What is a Mortgage?
A mortgage is a type of long-term installment loan used by borrowers to facilitate the purchase of a home.
To purchase a property in Canada, you must contribute a minimum down payment, depending on the home’s selling price.
Like a HELOC, a mortgage is a secured loan, so your home functions as collateral for your outstanding balance.
If you default on your payment obligations, your lender can seize your property and sell it to recover the principal owing.
However, unlike a HELOC, you cannot re-borrow any portion of the principal you repay.
The only way to extract the equity in your home is to refinance.
In Canada, you can expect to pay a minimum down payment of 5% on a home, which means you can finance up to 95% of your property’s value using a mortgage.
This type of mortgage is called a non-conventional or high ratio mortgage and necessitates the purchase of mortgage default insurance.
If your down payment is 20% or greater, your mortgage qualifies as a conventional mortgage, which absolves you of needing to pay for mortgage default insurance.
The interest rates you can expect to find on a mortgage are considerably lower than those compared to credit cards and lines of credit.
Since your home backs the loan, lenders feel more comfortable assigning low rates to mortgages.
As a borrower, you can select between variable rates and fixed-rate mortgages.
In the latter case, your interest rate will never change for the duration of your mortgage term.
Mortgages have strict repayment schedules.
You’re required to make timely payments at regular intervals, typically monthly or bi-weekly.
When applying for a mortgage, you can select between different terms, which refers to the length of time your mortgage contract remains in effect.
Terms range from 6 months to ten years.
Once your term ends, you’ll have the opportunity to renew your contract, where you have the option to renegotiate your interest rate and other features of your mortgage.
You can also switch to a new lender.
To qualify for a mortgage from a federally-regulated financial institution in Canada, you must pass the mortgage stress test.
Considerations When Choosing Between a HELOC and a Mortgage
A HELOC and mortgage can both help you finance your home purchase.
However, depending on your budget, goals, preferences, and risk tolerance, one may be more suitable for you than the other.
Here are some things to consider when deciding between these two loan products:
Down Payment Size
You can obtain a mortgage with as little as a 5% down payment.
Conversely, if you opt to finance a home purchase using a HELOC, be prepared to contribute 35%.
A HELOC comes with a variable interest rate, which means the rate initially assigned by your lender can increase or decrease at any time.
This attribute makes a HELOC riskier as you could get with hefty interest charges if rates spike.
Alternatively, you can select a fixed interest rate if you opt for a mortgage, making it a superior financing method if you prefer a predictable payment schedule.
A HELOC confers more benefits in terms of flexibility than a mortgage.
You can tailor your payment schedule to align with your lifestyle and budget and borrow only the amount you need when you need it.
Plus, you have the freedom to pay down your balance earlier by applying additional payments (which also helps to reduce your overall interest expense).
However, the lenient payment structure and freedom to draw funds can lead to severe financial trouble if you borrow too much and fall behind on payments.
With a mortgage, your lender sets you up with a strict, predetermined payment schedule, which you must adhere to or risk having your home foreclosed.
There are more restrictions regarding prepayments unless you choose an open mortgage.
However, if your budget easily accommodates regular, fixed payments and flexibility isn’t a priority, a mortgage will work fine for you as a financing source.
Frequently Asked Questions
- Is a HELOC easier to get than mortgage?
A HELOC is slightly more challenging to obtain as it offers more flexibility regarding payments. Also, in the event of a default, a mortgage has priority over the HELOC, which makes it riskier for a lender to issue.
Also, if you’re looking to substitute a mortgage with a HELOC, you’ll need a down payment of 35% to qualify.
This figure is considerably higher than the minimum down payment required for mortgage financing, which could be as low as 5%.
- Is HELOC rate same as the mortgage rate?
No. Lenders determine HELOC rates independently from mortgage rates. While they share similarities, these loan products have unique features, risk parameters, and eligibility criteria.
HELOC rates are variable, while mortgage rates can be variable or fixed. However, since HELOCs and mortgages are secured by tangible property, both offer low and comparable rates.