When homeowners in Canada need financing, they often weigh a home equity line of credit (HELOC) versus a traditional mortgage. Both are loans secured by your home, but they serve different purposes and work in distinct ways. Understanding the differences will help you choose the right option for your needs.
What is a Mortgage?
A mortgage is a loan used to purchase a property or refinance an existing property loan. It is secured by the property itself as collateral – if you fail to repay, the lender can foreclose and sell the home to recover the debt. With a mortgage, the full loan amount is advanced upfront to enable you to buy the home, and then you repay it over a long period (commonly 25 years in Canada) in regular installments. Each payment typically includes both interest and principal, following a set amortization schedule. This structured repayment gradually reduces your balance over time until the loan is paid off.
In Canada, mortgages can cover a large portion of a home’s price. For new home purchases, a mortgage can finance up to 95% of the purchase price if you have a small down payment (loans above 80% loan-to-value require mortgage insurance). For refinancing an existing home, you can borrow up to 80% of the home’s appraised value through a mortgage. These limits mean mortgages are ideal for major financing needs like buying a house or condo, where you often need a large lump sum.
Interest rates
Canadian mortgages offer a choice of fixed interest rates or variable interest rates. With a fixed-rate mortgage, your rate is locked in for a term (commonly 5 years), so your monthly payment remains predictable regardless of market rate changes. With a variable-rate mortgage, the interest rate can fluctuate with the prime rate, so your payment amount or the portion going toward interest may change if interest rates rise or fall.
Generally, mortgage rates are lower than HELOC rates because it costs the bank less to fund a standard mortgage, and the loan is often for a primary home purchase. This can make mortgages a cost-effective way to borrow large amounts.
Repayment
Mortgages are paid on a fixed schedule (usually monthly or bi-weekly payments). The payment includes principal + interest, and follows a set amortization timeline (e.g. 25 years), which means if you make all payments as scheduled, the loan will be fully paid off by the end of the term. This structured approach provides discipline and predictability – you know when your mortgage will be paid off as long as you stick to the schedule.
However, it also means less flexibility. Once the funds are disbursed and you start repayment, you cannot easily borrow more against the home without applying for a new loan or refinancing. Any additional funds you might need (e.g. for renovations or an emergency) would require taking out a separate loan or a line of credit. Additionally, if you want to pay off a mortgage faster or break the mortgage before the term ends (for example, selling the home or refinancing early), you might face prepayment penalties depending on your mortgage agreement.
Pros of Mortgages
- Large Upfront Loan for Purchases:
Allows you to buy a home with a small down payment, covering up to 80-95% of the price in Canada (making homeownership possible without massive cash savings).
- Lower Interest Rates:
Typically offers lower interest rates than other credit products or HELOCs, especially for well-qualified borrowers. This can save you money on interest costs over the long term.
- Fixed or Variable Rate Options:
You have the choice of rate type. Fixed rates provide stable, unchanging payments for the term, which is great for budgeting. Variable rates may be initially lower and can adjust with the market (with potential savings if rates drop).
- Predictable Payments and payoff:
With a fixed-rate mortgage, your payment amount is consistent, and the loan has a clear end date. The structured amortization means you are steadily building equity by paying down principal on a set schedule. Long amortization periods (e.g. 25-30 years) also mean manageable monthly payments for large loans.
Cons of Mortgages
- Less Flexibility in Borrowing More:
Once you’ve taken the mortgage and start repaying, you cannot re-borrow paid-down amounts without a refinance. Accessing additional equity (beyond minor prepayments you can later re-borrow) usually means getting a separate loan or refinancing, which can be costly and inconvenient.
- Rigid Payment Schedule:
You’re locked into a payment schedule and contract. Missing payments can lead to serious consequences, and you have limited ability to adjust payment amounts or timing. You must budget for the mortgage payment as a non-negotiable expense every month.
- Prepayment Penalties:
If you try to pay off the mortgage early, refinance before the term is up, or break the mortgage contract, you might incur penalties. For example, many fixed mortgages charge an interest penalty if you exceed your annual prepayment limit or break the loan early. This makes mortgages less flexible if your plans change.
- Requires Qualifying and Down Payment:
You must qualify based on income, credit, and debt ratios for the large loan, and you need at least the minimum down payment (e.g. 5%+ for purchases, or 20% equity for an uninsured mortgage). While not a “con” in the product itself, it’s a consideration that getting a mortgage has stricter approval criteria and upfront cash requirements (down payment, closing costs).
What is a Home Equity Line of Credit (HELOC)?
A Home Equity Line of Credit (HELOC) is a revolving line of credit secured by your home’s equity. “Equity” means the portion of the home you actually own – your home’s market value minus any outstanding mortgage balance. A HELOC lets you borrow against this equity on an ongoing basis. Instead of receiving a lump sum, you’re approved for a credit limit (for example, say $100,000) and you can draw from it as needed, only up to that limit. As you repay what you’ve used, those funds become available to use again. This works much like a credit card, but with your house as collateral.
In practice, a HELOC often serves as a second mortgage on top of your primary mortgage. Many Canadian homeowners get a HELOC after building up equity, to have readily available funds for home renovations, emergencies, investments, or other large expenses. Notably, you can use HELOC funds for any purpose – there are no restrictions that it must be for the home itself. For example, you could use a HELOC to fund a child’s education or consolidate higher-interest debt. Because the loan is secured by your house, HELOC interest rates are significantly lower than credit cards or unsecured lines of credit, making it a relatively cheap way to borrow for those who have equity.
- Borrowing limits
Canadian regulations limit how much you can borrow with a HELOC. Generally, a standalone HELOC (by itself) can go up to 65% of your home’s appraised value. If you also have a mortgage on the property, the combined total of the mortgage balance plus HELOC limit cannot exceed 80% of the home’s value. In practical terms, this means you need to retain at least 20% equity in your home.
For example, if your home is worth $500,000 and you have a $300,000 mortgage (60% of value), the maximum HELOC limit would be $100,000 (which brings you to 80% total loan-to-value). If your home is fully paid off, a bank might offer a HELOC up to 65% of $500,000 = $325,000. These limits ensure you don’t over-borrow against your property. Also, lenders will assess your income, credit score (typically need a good credit score ~680+), and debt ratios to make sure you can handle the credit line. Like mortgages, HELOC borrowers must pass the federal mortgage stress test, proving they could afford payments at a higher interest rate, due to the variable-rate risk.
- Interest rates
Most HELOCs have variable interest rates, often quoted as Prime + X% (an interest premium above the lender’s prime rate). For example, if the bank’s prime rate is 6%, your HELOC might be at prime + 0.5%, meaning you pay 6.5% interest. As the prime rate moves up or down, your HELOC rate will adjust accordingly. Unlike mortgages, fixed-rate options are not common for HELOCs – they are generally floating rate products.
It’s also worth noting that HELOC interest rates tend to be higher than mortgage rates. Banks charge a premium for the flexibility of a HELOC and the fact that it’s often second in priority (after your mortgage) if you default. So while a variable mortgage might be Prime – 0.5%, a HELOC could be Prime + 0.5%, for instance. You are only charged interest on the amount you actually borrow from the line at any given time, not on the total credit limit available. This means if you have a $100,000 HELOC but only use $20,000 for a kitchen renovation, you’ll only pay interest on that $20,000 balance, and the remaining $80,000 of available credit costs nothing until used.
- Repayment flexibility
One of the biggest advantages of a HELOC is its flexible repayment. Typically, lenders require only a minimum monthly payment of interest on what you’ve borrowed. You often have the option (but not the obligation) to pay back principal whenever you want, in any amount. In fact, you could theoretically make interest-only payments for an extended period, and then pay off the principal in a lump sum later.
There are no penalties for prepayment on a HELOC – since you aren’t locked into a term, you can repay any or all of the balance whenever you like. This makes HELOCs very attractive for short-term borrowing needs or situations where your cash flow varies. For example, if you’re self-employed or get an annual bonus, you might borrow as needed during the year and then pay down a chunk when funds are available. Access to funds is revolving, meaning as you repay principal, you can re-borrow it again without reapplying. This can act as a financial safety net for ongoing or unexpected expenses.
However, the flip side of this flexibility is that HELOCs do not have a built-in repayment discipline. If you only pay interest and never pay down principal, you’re not actually reducing your debt (some HELOCs may require occasional principal payments, but generally you control the repayment pace). It’s up to the borrower to manage their payments responsibly to eventually eliminate the debt.
It’s even possible to use a HELOC instead of a traditional mortgage in some cases (often called a readvanceable mortgage when combined). For instance, if you have a very large down payment or equity (35% or more), you could finance a home purchase partly or entirely with a HELOC. In Canada, you could use a HELOC for up to 65% of the purchase price and then cover the remainder with cash down payment (at least 35% down).
Some lenders also offer hybrid mortgage HELOC products where, if you put at least 20% down, your loan is split into a mortgage portion and a HELOC portion. This gives you the stability of a mortgage for part of the loan and the flexibility of a line of credit for additional borrowing. These options are typically for more financially secure borrowers, and the interest rate on the HELOC portion may be higher. In general, most homebuyers use a standard mortgage for the bulk of the purchase and might add a HELOC later for flexibility once equity is built.
Pros of HELOCs
- Flexible Access to Cash:
You can borrow as little or as much (up to the limit) whenever needed, and you don’t have to take it all at once. This is ideal for expenses that occur over time (e.g. multiple home improvement projects or periodic tuition payments) since you can draw funds on demand. You only pay interest on the amount you actually borrow, not the total credit line.
- Interest-Only Payments Available:
HELOCs allow interest-only payments, which means your monthly payments can be very low when you carry a balance. This can significantly ease cash flow in the short term. You have the option to pay extra toward principal when it suits you, without penalty. This flexibility can be helpful if your income fluctuates or if you’re managing other debts.
- No Fixed Term or Maturity (Revolving Credit):
Unlike a loan that must be paid off by a certain date, a HELOC is revolving – as long as you abide by the terms (keep up with interest payments, stay within your limit), you can keep the line open indefinitely. There’s no need to reapply each time you want to use your equity, and no need to renew as you do with mortgages at the end of a term. Many HELOCs are effectively open-ended lines of credit secured by your home.
- No Prepayment Penalties:
Because there’s no set schedule to pay down principal, you won’t be penalized for paying off your HELOC balance quickly or closing the line. You have total freedom to repay early or in large lump sums at any time. This makes HELOCs useful as a temporary financing tool – for example, you could use a HELOC to bridge a short-term need and then pay it off with a future bonus or sale of an asset, all without extra fees.
Cons of HELOCs
- Risk of Overspending and Debt Growth:
The easy, on-demand access to cash can be risky if not managed well. It’s tempting to borrow more than you truly need, and without a set repayment plan, some people end up not paying down their HELOC for a long time. This is why HELOCs have been noted as a major contributor to consumer debt in Canada. Discipline is required to avoid using your home like an ATM and accumulating debt that might jeopardize your financial security.
- Variable Interest Rate Uncertainty:
HELOC interest rates are usually variable, so your cost of borrowing will rise if interest rates go up. For example, if prime increases, the interest on your HELOC balance increases immediately. This can make your payments unpredictable and potentially expensive over time. In contrast, a fixed-rate mortgage shields you from rate hikes. If the Bank of Canada raises rates, HELOC borrowers will feel it. You must be prepared for the possibility that your interest-only payment one month could be higher in the next month due to a rate change.
- Higher Interest than a Mortgage:
While cheaper than credit cards, HELOC rates are generally higher than mortgage rates. Over a long term, carrying a large balance on a HELOC can cost more interest than if that amount were on a mortgage. If you end up needing a big sum for a long duration, a refinance into a lower-rate mortgage might save money compared to keeping it on a HELOC.
- Collateral at Risk:
Just like a mortgage, a HELOC is secured by your home – if you fail to make payments, the lender can ultimately foreclose on your house to recover the debt. Some people may forget that even though a HELOC feels like simple credit, it has serious consequences if not repaid. Additionally, using a HELOC reduces the equity in your home, which could affect you if property values drop or if you plan to sell your home (since the HELOC would need to be paid off from sale proceeds).
HELOC vs Mortgage: Head-to-Head Comparison
Purpose and Usage: A mortgage is intended for buying a home or refinancing an existing home loan. In fact, you generally cannot purchase a home with a HELOC alone unless you have a very large down payment (35% or more). A HELOC is meant for accessing home equity in a property you already own (or alongside a mortgage) to finance other needs.
Think of a mortgage as the primary loan that gets you into a home, while a HELOC is a secondary tool for leveraging your home’s value for cash. If you’re buying a home and don’t have sufficient upfront funds, a mortgage is the way to go. If you already have a home and need funds for other goals, a HELOC can unlock your equity without selling or refinancing your entire mortgage.
Loan Disbursement
With a mortgage, you receive the full amount upfront at closing (e.g. the entire $400,000 loan is given to your home seller or your previous lender if refinancing). With a HELOC, you are approved for a credit limit (say $100k) but you withdraw only what you need, when you need it – you could take $10k now, later $5k, etc., up to the limit. You don’t pay interest on unused HELOC funds, whereas with a mortgage you pay interest on the full amount from day one. This makes HELOCs more flexible if you’re unsure how much money you’ll require over time.
Repayment and Term: A mortgage has a structured amortization term (often 25 years), meaning it’s designed to be fully paid off by a certain date through regular payments. Mortgages in Canada usually have shorter terms (e.g. 5-year term) after which you must renew or refinance at the remaining balance, but the overall amortization schedule continues. A HELOC is open-ended – there is no set amortization; you could theoretically never fully repay principal until you sell the house (though lenders can demand interest-only payments monthly). You have flexibility to pay principal on your own schedule. Mortgages thereby provide a built-in plan to get debt-free, whereas with a HELOC, you must impose that plan on yourself.
Interest Costs
Mortgages typically offer the lowest interest rates available for home financing, especially if you choose a fixed rate during a low-rate environment or have a high-ratio insured mortgage. HELOCs carry a higher rate (often a point or two above prime) and that rate can change with the market. Over the long run, if you carry a balance, a HELOC will usually cost more interest than an equivalent mortgage loan. However, for short-term or intermittent borrowing, a HELOC’s pay-as-you-use structure can be cheaper since you’re not paying interest on a large sum you didn’t need for the entire period.
Flexibility
This is where HELOCs shine. You can re-borrow again and again as you repay, and you can adjust your repayment amounts (pay a lot one month, just interest the next) without penalty. A mortgage offers far less flexibility – you borrow once and repay on a fixed plan. To get more credit, you’d need to apply for a new loan.
To change your payment or pay off early, you might incur fees. Essentially, a mortgage is “set it and forget it” for a specific purpose, whereas a HELOC is like a credit card with a huge limit and low interest for homeowners. The trade-off for HELOC flexibility is the need for financial discipline and risk management, as mentioned.
Closing Process and Fees
Getting a mortgage (or refinancing one) involves a formal application process, income verification, a property appraisal, and closing costs (legal fees, possible appraisal fees, land transfer tax on purchase, etc.). Setting up a HELOC also requires an application, credit review, and often a home appraisal and legal work to register the lien.
In many cases, if you set up a HELOC concurrently with your mortgage (or from the same lender), the process is streamlined. If you add a HELOC later, you’ll have some one-time setup costs (some lenders charge an application fee or appraisal fee for a HELOC). However, once a HELOC is in place, you generally don’t have ongoing renewal fees like a mortgage might at term end. Both products will have administrative costs to consider, but these are typically one-time for a HELOC and periodic for a mortgage (if you switch lenders or refinance).
Which Option is Right for You?
Both mortgages and HELOCs are useful tools – the right choice depends on your situation and financial goals. Consider the following factors when deciding between an equity line of credit and a mortgage:
- Purpose of the Loan
If you are purchasing a home or need a large lump sum (and want the lowest rate), a mortgage is usually the appropriate choice. For accessing equity in an existing home for other expenses, a HELOC might be more suitable. Think about whether you need all the money up front to buy/refinance (mortgage), or if you prefer a reservoir of funds to draw from over time (HELOC).
- Amount Needed and Equity Available
If you require more than 65-80% of your home’s value in financing, a mortgage (or a combination mortgage + HELOC) will be necessary because a HELOC alone won’t suffice. If you have substantial equity and only need to borrow a smaller portion occasionally, a HELOC lets you tap that equity without restructuring your primary mortgage.
- Interest Rate Considerations
In a low or stable interest rate environment, a variable-rate HELOC can be attractive. However, if rates are rising or volatile, locking in a fixed mortgage rate can provide peace of mind and predictable payments. Also, if minimizing interest cost on a large balance is a priority, a mortgage’s lower rate could save money. Consider the outlook for interest rates and how comfortable you are with rate fluctuations when choosing.
- Repayment Discipline
Are you the type who will proactively make extra payments to reduce debt? If not, a structured mortgage forces you to pay down principal on schedule, which can be a good thing for many people’s financial health. A HELOC requires discipline – you must commit to paying more than just interest to actually pay it off. If you worry that having a line of credit might tempt you to overspend or only pay the minimum, a closed-end mortgage might prevent accumulating too much debt. On the other hand, if you are confident in your budgeting and want flexibility, a HELOC gives you freedom to manage your payments.
- Cash Flow Needs
If your income is steady and you can handle a fixed payment, a mortgage’s consistency is fine. But if you anticipate irregular expenses or temporary income dips, the interest-only payment option on a HELOC can provide breathing room in tight months. Just be cautious not to let the debt linger too long.
- Combining Both
Remember, it’s not always either/or. Many Canadians use both: a mortgage for the initial home purchase, and later a HELOC for additional borrowing needs. Some lenders even bundle them together (readvanceable mortgages) so that every mortgage payment you make automatically increases your available HELOC credit. This combo can offer a balance of stability and flexibility if used wisely.
There is no clear “winner” in the HELOC vs. Mortgage debate – they are different financial tools for different purposes. A mortgage is usually best for financing a home purchase or large, long-term loan at the lowest possible interest rate, with a defined plan to pay it off.
A home equity line of credit is optimal when you need flexibility to borrow against your home for various purposes, prefer to control the timing of borrowing and repayment, and can manage the responsibility that comes with that freedom. In many cases, a mortgage and a HELOC can complement each other: you might take a mortgage to buy your home, then later obtain a HELOC to fund renovations or other goals using the equity you’ve built.
Evaluate your financial goals, borrowing needs, and discipline. If you’re still unsure which option is right for your situation, consider speaking with a mortgage professional. They can explain your options in detail and help you make an informed decision tailored to your needs. With the right choice, you can leverage your home’s value in the most effective way – whether that’s the predictable path of a mortgage or the flexible route of a home equity line of credit.
