How does line of credit interest work on a drawn balance?
Interest on a home equity line of credit accrues only on the money you have actually drawn. If your approved limit is larger than your balance, the undrawn room costs you nothing in interest. That is the main structural difference between a line of credit and a closed mortgage, where the whole principal is advanced at once and interest runs on that full amount from the start.
Most home equity lines of credit carry a variable interest rate on a line of credit described as a benchmark plus or minus a spread. The benchmark is usually the lender's prime rate, and prime moves when the Bank of Canada's policy rate moves. The Bank of Canada publishes the policy interest rate, the prime rate, conventional mortgage rates and Government of Canada benchmark bond yields. Those are benchmarks, not offers, and no lender is obliged to lend at them. Your agreement sets your actual rate.
Once you have a rate, interest is calculated on your outstanding balance. In practice most lenders calculate interest daily and post it to the account on a schedule set out in the agreement, which is why the exact day count and posting rules matter more than people expect. Drawing money right after a payment posting date rather than right before it can change how much interest lands on the next statement. The one reliable rule is that the method is written into the credit agreement you signed, so read that document rather than assuming a formula.
Canada does have an outer legal ceiling. The Criminal Code criminal rate of interest is 35% per year (s. 347), so no credit agreement can lawfully charge an effective annual rate above that.
One contrast is worth knowing. Canadian fixed-rate mortgages are compounded semi-annually by law, while a variable line of credit is calculated on the outstanding balance in the way the agreement specifies. That difference in mechanics is one reason the two products behave differently when rates move.
Draw period and repayment period: what each one means
A home equity line of credit normally has two phases, and the phase you are in decides your line of credit payment far more than any other single factor.
The draw period. During this phase the credit is revolving. You can draw, repay, and draw again up to your limit. The minimum payment is commonly interest only, though some lenders ask for a small percentage of the balance instead, and some set a minimum dollar amount. If you pay only the interest, your balance does not fall. You are covering the cost of the money, not reducing the debt.
The repayment period. At some point the credit stops revolving. You can no longer re-borrow what you repay, and the balance is paid down on a schedule, usually over a set number of years. The payment now covers principal and interest together.
The move from one phase to the other is often called conversion, and it can be triggered in more than one way:
- a scheduled date written into the agreement, such as the end of a stated draw period;
- the lender requiring repayment, if the facility is structured that way;
- a change in your circumstances that the agreement names as a trigger;
- a sale of the property, or a refinance that pays the line off.
Because terms differ, the useful thing to do is find the conversion clause in your own agreement and write down the date and the conditions. That single paragraph tells you more than any general rule.
Why the payment can jump at conversion
Three effects usually stack up at the same time.
- Principal enters the payment. An interest-only payment covers interest alone. A principal-and-interest payment covers interest plus a slice of the balance, so the payment rises even if the rate has not moved at all.
- The amortization is shorter. A repayment period is usually shorter than the amortization on a typical mortgage, so each payment has to carry more principal. A shorter amortization means a larger payment for the same balance.
- The rate may have moved while you were drawing. If your rate is variable and the benchmark has risen since you opened the line, the starting point for the repayment calculation is higher than the rate you originally budgeted for.
There is a fourth effect that is easy to miss. If you spent the draw period paying interest only, the balance at conversion is whatever you drew, not what you originally planned to owe. A payment calculated on a full balance over a shorter amortization is what produces the shock people describe.
Comparing the two phases side by side
| Feature | Draw period | Repayment period |
|---|---|---|
| What the credit does | Revolving: you can re-borrow what you repay | Closed: the balance only goes down |
| What your payment covers | Commonly interest only, or a set percentage of the balance | Principal and interest |
| What drives the payment | Your drawn balance and your current rate | The amortization schedule, the balance and your rate |
| If the rate rises | Interest cost rises on the same balance | Interest cost rises and the schedule may be recalculated |
| Effect on the balance | Flat if you pay interest only | Falls with every payment |
| Main risk | Treating the limit as income and never reducing principal | A payment larger than your budget allows |
Neither phase is automatically better. A long draw period with interest-only payments keeps cash flow flexible and costs more over time. A repayment period costs more each month and clears the debt. Which fits depends on your income stability, your other debts and how long you expect to hold the property.
What decides your rate and your limit
Your rate is a pricing decision the lender makes about you, and it is not published as a single number. The benchmark matters, but so does everything the lender sees about the risk of lending against your home.
- Your property and loan-to-value. At federally regulated lenders, a home equity line of credit is generally limited to 65% of appraised property value, with total secured lending usually capped at 80%. A higher combined loan-to-value narrows your options.
- Your debt service ratios. Federally regulated mortgage lenders generally work to a total debt service ratio ceiling of about 44%, and qualify an uninsured mortgage at the greater of the contract rate plus 2 percentage points and 5.25% under OSFI Guideline B-20.
- Your credit history. Payment history and how your accounts are reported by Equifax Canada and TransUnion Canada feed the lender's view of you.
- Your income and its stability. Documented, predictable income supports a better price than income the lender cannot verify.
Because of that, pricing is tiered. The lowest rates are only available to the most qualified applicants. A quoted rate you see advertised is a starting point for a conversation, not a number you are entitled to.
Loanmoose.ca is not a lender. It does not make loans, set rates or make credit decisions. It is a matching and comparison service that helps you find and compare providers, and any rate, limit or approval comes from the lender you deal with.
Keeping the line of credit payment manageable
You cannot control the benchmark, but you can control several things that decide what you pay:
- Pay more than interest during the draw period, even a small fixed amount, so the balance at conversion is lower.
- Ask whether the lender offers a fixed-rate portion or a locked sub-limit, and what it costs.
- Ask for the conversion date and the repayment terms in writing before you sign, not after.
- Check whether the facility is demand-based and what the agreement says about repayment on demand.
- Avoid using a line of credit for spending that does not build an asset, because the balance outlives the purchase.
- Review the rate when the benchmark moves, and test your budget against a higher payment than you pay now.
This is general information about how the product works, not financial advice. Whether a line of credit, a term portion or a different structure suits you depends on your circumstances, and for a significant decision you should speak with a regulated professional.
Where to check details or raise a concern
The Financial Consumer Agency of Canada publishes consumer information on mortgages and secured credit, including what lenders must disclose to you. Consumer complaints about federally regulated financial institutions go to the Financial Consumer Agency of Canada. Lending in Canada is licensed provincially, so the regulator and the rules differ depending on who you are dealing with, and provinces license and supervise most other lenders.
Before you sign, ask for the disclosure document that states your rate, how interest is calculated, the draw period, the repayment period and the payment schedule. Those five items answer most of what borrowers get caught by.