Lines of Credit in Canada: How They Work

A line of credit is a kind of pre-approved loan that provides the borrowing flexibility of a credit card with lower interest rates. Financial institutions typically offer a few different line of credit options, each with different terms depending on their structure and intended use.

How a line of credit works

A line of credit is a form of revolving credit with a predetermined limit so you’re not required to re-apply when you need funds. You can borrow any amount up to your limit at any time. Repayment is only required if you have an outstanding balance.

The minimum payment on a line of credit may be just the interest on the amount borrowed, or may follow a formula such as “the greater of 2% of the outstanding balance or $50.” Since the minimum payments won’t relieve you of your debt as promptly, it’s up to you how quickly you want to pay off your line of credit.

Accessing and repaying your line of credit can typically be done in multiple ways, such as through online banking platforms or an ATM.

Secured vs. unsecured lines of credit

A line of credit is either secured or unsecured.

A secured line of credit is backed by collateral, such as a house. This collateral offers security to the lender and generally means your interest rate will be lower than it would be for an unsecured line of credit. However, if you default on your payments, the bank can seize the asset that secures the line of credit.

An unsecured line of credit has no collateral. As a result, these lines of credit can be trickier to qualify for and will typically have a higher interest rate.

Types of secured lines of credit

Home equity line of credit (HELOC): A HELOC is a common type of secured line of credit. Because it is secured against the equity in your home, the credit limit tends to be higher. While there are no restrictions on how you can spend HELOC funds, it’s commonly recommended that equity be reserved for uses that offer a return on investment, such as improving or updating your home.

Types of unsecured lines of credit

Personal line of credit: Personal lines of credit generally have higher interest rates than HELOCs but the rates are still lower than those of credit cards and some personal loans.

Student line of credit: This kind of line of credit is intended to finance post-secondary education expenses, and to get one, you may need to prove that you’re attending a recognized Canadian school. Additionally, students may need a co-signer, often a parent, as they may not have established credit history or a strong credit score.

Student lines of credit may have the advantage of lower interest rates over government student loans but here’s something to consider — line of credit payments start immediately, whereas student loan repayments tend to begin after you’ve graduated from school.

Line of credit interest rates in Canada

The interest on a line of credit is variable, which means it fluctuates with the prevailing interest rates. This interest rate is expressed as the lender’s prime rate which is based on the policy interest rate set by the Bank of Canada, plus a percentage.

Secured lines of credit typically have the best interest rates, such as prime + 1%. So if the lender’s prime rate is 3%, for example, your line of credit interest rate will be prime + 1% which comes to 4%. But if the lender’s prime rate increases to 4.5%, your rate will increase to 5.5%.

Unsecured lines of credit work similarly, except with higher interest rates. The rate you are offered will depend on certain financial criteria, such as income, personal assets and credit score. If you have a long history with a particular financial institution, you may be able to negotiate a lower interest rate on your unsecured line of credit.

How to get a line of credit

Lines of credit are commonly available at banks, credit unions and other financial institutions, such as online-only banks. You can typically apply for a line of credit online, over the phone or in person.

Just as when you apply for other forms of credit, the lender will require financial information to determine your eligibility, interest rate and repayment terms.

During the approval process, the lender will consider criteria like:

Household income: A minimum annual income of $35,000 to $50,000 is often required to be considered for a line of credit. Employment history will also be a factor, as income stability can affect your ability to make payments.
Assets and/or liabilities: These factors help the lender evaluate your financial security and ability to repay the line of credit.
Credit score and credit history: The better these are, the more favourable your terms and interest rate are likely to be.

In the case of secured or student lines of credit, additional criteria such as a home appraisal or proof of admission will be required.

How much can you borrow with a line of credit?

Unsecured lines of credit tend to start at $5,000. The exact amount you’re approved to borrow depends on the lender’s review of your personal financial information.

Other lines of credit may require you to pay the registration or administration charges, and monthly or annual fees.

Line of credit pros and cons

Pros

Interest rates tend to be lower than those of credit cards or personal loans.
Flexible repayment structures allow you to pay down your line of credit as swiftly or steadily as you wish.
Only pay interest on the amount you borrow.
Your bank may allow you to transfer overdrafts to your line of credit, so you can avoid overdraft fees.
Access and repay your line of credit easily through online banking or even through ATMs if you link it to your debit card.

Cons

Easy access to funds could lead to overspending and a cycle of debt.
Carrying a large outstanding balance could hurt your credit score.
Variable interest rates could lead to larger payments and additional overall interest being charged on your debt.
If you fail to make payment on your secured line of credit, you could risk losing the collateral, which could be your home.

Alternatives to a line of credit

Unsecured line of credit alternatives

Personal loans: A one-time fixed loan amount with a fixed payment schedule.
Credit cards: A revolving credit option, but with much higher interest rates. Additionally, if you need cash, a credit card cash advance entails extra fees and interest charges.

Secured line of credit alternatives

If you own a home and are willing to use it as collateral, options for extracting equity include:

Cash-out refinance: With this type of mortgage refinance, you can borrow up to 80% of the appraised value of your home, minus the amount left on your existing mortgage and any other loans against the house.

Second mortgage: Whereas a cash-out refinance increases your primary mortgage amount, a second mortgage is taken on in addition to your primary mortgage. This is appealing if interest rates have gone up and your original mortgage has a low fixed rate that you want to keep locked in.

Reverse mortgage: Homeowners age 55 and older who wish to stay in their home and live on the equity without making loan payments may be interested in this financing option. A reverse mortgage comes due in full when you sell or move, or the last borrower dies. You can borrow up to 55% of the home’s value, although interest rates will be higher than the above options.

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