Mortgage vs. HELOC

Mortgage and HELOC are financial products designed to provide credit against the security of a property.

A mortgage is a loan secured by a property.

HELOC stands for Home Equity Line of Credit. It enables a property owner to borrow against it.

Nature of Financing

A mortgage is a loan that is created with a fixed repayment schedule. Once an instalment is paid back, the loan value outstanding reduces and cannot be increased, unless you renegotiate the terms.

A HELOC is issued as a line of credit. You can take out, and pay interest on, only as much as you need and keep servicing your interest which could also be directly debited to your account. You can put back the money borrowed as and when you can, to reduce interest accrual.

Some HELOCs may have an amortizing mortgage portion, but that generally comes with flexible monthly payment schedules.

Purpose and suitability

A mortgage loan is usually taken for the purpose of acquiring a property. For a typical first property buyer who wishes to place as small a down payment as possible, a mortgage is the recommended facility.

A HELOC, as it is typically against an existing property, is handled like a line of credit, the purpose is flexible. You can use it for home renovations, education or other financial needs.

In some cases, HELOCs may be more suitable for buying a property, like for purchasing a property for investment that you plan to sell in the not-too-distant future.

Upfront requirement

A mortgage will require a down payment to cover the difference, as a lender will not finance the entire assessed value of the property. For example, if the lender provides 80% of the value as a mortgage loan, the borrower will need to find the balance 20% to purchase the property.

A HELOC does not have any such requirement. It could have some processing charges levied by the lender, but that is unlikely to be a large amount.

Cost

A mortgage has a fixed payment/ repayment schedule, making the cash flows predictable and cheaper for the lender to fund. This makes mortgage loans cheaper than HELOCs where borrowing and repayment are undefined in terms of value and time.

However, when compared with lines of credit, which is what they are, HELOCs will be cheaper for borrowers as the lender, with the security of the property, carries a lower risk.

Prepayment

A mortgage has a defined payment schedule that covers principal as well as interest. Prepayment will usually entail an additional cost for the borrower.

HELOC being in the nature of a line of credit, the borrower can take money out, up to the defined limit, and put it back in, as per requirement, without incurring addition charges for doing so.

Separate or together

A mortgage will usually not be available for a property that is already being used as a security for another loan.

However, a HELOC can be obtained for a property that has been purchased through a mortgage loan, once enough has been repaid to leave enough residual value for a lender to find material. It is based on home equity, the difference between the value of the property and and the outstanding mortgage amount and/or other loans secured on it. For example, if your home is worth $500,000 and your mortgage balance is $200,000, your home equity is valued at $300,000.

A HELOC can be added on top of a mortgage.

Qualifying requirements

Both mortgage and HELOCs have similar qualifying requirements, that include:

  • Good credit (at most lenders, that means a score no lower than 680)
  • Demonstration or proof of income
  • Debt ratios that are reasonable, less than 40% desirable but 50% may also be adequate

In addition, for a mortgage, the borrower will need to demonstrate a steady income that will enable repayment of the instalments. The borrower should also be in a position to fund the down payment for the property as the lender will only lend an amount less than 100%.

For a HELOC, a borrower will need to hold a minimum of 20% equity in the property sought to be used as collateral, and more if the amount sought is higher.

The Financial Forum for borrowers

Mortgages and home financing are important financial decisions. The Financial Forum makes mortgages and HELOCs easy for borrowers. We don’t work for any lender; we work for you, the borrower. Reach us on (905) 265-0246 or mortgages@thefinancialforum.ca.