Home Equity Loans & Mortgages

If you’re a homeowner, you may have accumulated some equity over time. If so, you might be able to use this equity to fund a large expense. For instance, a home renovation, college tuition, or an expensive purchase like a boat might require a hefty sum of cash. In these cases, you can cover the cost using your equity accessed through a home equity loan.

Let’s take a closer look at how you can use your home equity to get your hands on some extra cash.

Key Points

• Home equity refers to the difference between your remaining mortgage amount and what your home is worth. 
• You can access your home equity through a HELOC or home equity loan and use the funds to pay for a variety of large expenses.
• Your home collateralizes a HELOC or home equity loan, which makes these financing products easier to qualify for at lower rates compared to other loan types.
• Since your home secures a HELOC or home equity loan, it’s important that you keep up with loan payments, or your lender may repossess your home.

What Is Home Equity?

Your home equity refers to the value of your home minus the amount you still owe on your mortgage. When you purchase a house, you’re considered the owner. But, until your mortgage is paid off completely, your lender retains an interest in the house. That means you don’t technically own the home in its entirety until you pay off your mortgage. 

Home equity increases in two ways:

• By making mortgage payments
• Through appreciation in value of your house over time

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service and education platform.

How To Calculate Your Home Equity?

Home equity is calculated using the market value of your house minus the balance of your mortgage. So, the formula would be as follows:

Property value – outstanding loan balance = home equity

For instance, let’s say the current market value of your home is $650,000, and you still owe $200,000 on your mortgage. Using these figures, your home equity would be calculated as follows:

$650,000 – $200,000 = $450,000

In this example, you would have $450,000 equity in your home.

But, keep in mind that if you want to know the official amount of equity you have built up, or if you’re interested in leveraging your equity as collateral, you will need to have your house appraised. 

Home Equity Loans And HELOCS

There are two main ways you can tap into your home equity: through a home equity loan or a home equity line of credit (HELOC). 

What Is A Home Equity Loan?

A home equity loan works a lot like a secured personal loan. This loan that is secured against the equity in your home and is often referred to as a second mortgage. Payments are fixed and terms range between 5 to 30 years. They generally have lower rates than most credit products but are usually higher than the original mortgage rate.

How Does A Home Equity Loan Work?

Like a regular installment loan, you’ll be funded in a lump-sum amount of cash that you can use according to your needs. You’ll make fixed payments with interest over a period of time, usually between 5 to 30 years. 

Interest rates on home equity loans are typically higher than a regular mortgage but lower than a regular personal loan. Moreover, rates are typically fixed, so payments are consistent and easy to budget. Do note that if you fail to make your payments, your lender can seize your property to recoup payment.

What Is A HELOC?

A HELOC — or home equity line of credit — is a type of financial program that allows you to borrow the equity in your home to access cash when you need it. When you take out a HELOC in addition to a separate first mortgage, you consider the HELOC a second mortgage.

Types Of HELOCs

There are two main types of HELOCs: those that are tied to your mortgage, and those that aren’t.

• HELOCs tied to your mortgage — A HELOC that’s bound to your home loan requires that you hold both your HELOC and mortgage with the same lender. Since the HELOC is affiliated with your current mortgage, you can borrow up to 80% of your home’s value.
• Independent HELOCs — These standalone HELOCs are not linked to your mortgage and allow you to borrow up to 65% of your home’s value.

How Does A HELOC Work? 

Unlike a traditional loan in which a you receive a lump sum of money and repay it in fixed installments, a HELOC works more like a credit card. You can draw from the line of credit up to your maximum spending limit as often as you like. Then, you can repay as much or as little of the withdrawn amount monthly.

In this way, a HELOC offers you plenty of flexibility to borrow against your home equity. Once you repay the money, you can borrow again and again on an as-needed basis, rather than taking out individual loans whenever the need for extra money arises. HELOCs typically come with variable interest rates, which means the rate on your HELOC will fluctuate with the prime rate.

How To Calculate How Much You Can Borrow Through Your Home’s Equity?

The maximum amount that you can borrow through your home’s equity is based on a few factors, including the following:

• Your home’s value
• The percentage of your home’s value that your lender will let you borrow against 
• The amount still left to repay on your mortgage

To illustrate, let’s say your home is currently worth $700,000 and you still owe $400,000 on your mortgage. If your lender allows you to borrow up to 80% of the value of your home, that means you can borrow a maximum of $560,000 ($700,000 x 80%). 

Then, subtract your outstanding mortgage amount from this figure to arrive at the amount you can borrow. In this case, that would be $160,000 ($560,000 – $400,000).

Home Equity Learning Resources

Pros And Cons Of A HELOC

There are a handful of perks and drawbacks of a HELOC that you should be aware of before applying.

Pros Of A HELOC

• Competitive rates — HELOC interest rates are usually lower than they are with personal loans because they’re secured against your home. 
• Easy access to funds — Once you have your HELOC set up, you can draw from your home equity as the need arises without having to repeatedly apply for separate loans. 
• Pay interest only on the amount used — Rather than paying interest on the entire credit limit, you only pay interest on the amount that you withdraw. And once you repay that money, you no longer have to pay interest on it. 
• Bad credit accepted — You may find it easier to get approved for a HELOC compared to a traditional personal loan. This is because you already have a mortgage and a home to collateralize the HELOC. In this case, a lower credit score may be acceptable.

Cons Of A HELOC

• Variable interest rates — Since the rate on your HELOC is based on the Prime Rate, your HELOC rate will increase if the Prime Rate goes up.
• Risk of overspending — If you have a tendency to lose control over your spending habits, you might find it too tempting to tap into your home equity through a HELOC. This can lead you into excess debt that can be tough to get out of. 
• Risk of repossession — Your home serves as collateral for your HELOC. So, if you fail to repay your HELOC according to your contract terms, your lender can seize your home to recoup any losses. 
• Fees — There are fees associated with setting up a HELOC, including the cost of a home appraisal.

Pros And Cons Of A Home Equity Loan

Just like a HELOC, there are pros and cons to using a home equity loan. Based on your needs and financial circumstances, one option may be better than the other.

Pros

• Fixed rates – With a home equity loan, your monthly payments won’t rise or fall like they would for a variable interest rate. The payments are consistent and easy to budget.
• Lower rates – Compared to personal loans and credit cards, interest rates on a home equity loan are usually much more affordable. This is because of the value of the asset backing the loan.
• Versatile – Unlike a mortgage or car loan, a home equity loan can be used for any expense. Whether you want to renovate your home, cover an unexpected expense or make a big purchase, you can do so using a home equity loan.

Cons

• Secured – The biggest risk to using a home equity loan is the collateral. If you miss payments, the lender has the right to seize your home and sell it to recoup payment.
• Fees – When you take out a home equity loan, there are certain fees you’ll need to pay, including closing fees and a home appraisal fee.
• Additional debt – While a home equity loan allows you to tap into your home’s equity, it also means you’ll be taking on more debt. Technically, you’ll have two mortgages, since a home equity loan is secured by your home and is referred to as a second mortgage.

How Will A Home Equity Loan Affect My Credit Score?

Any time you apply for new credit, your credit score may be affected. That’s because your lender will access your credit file to assess your creditworthiness, which is referred to as a “hard pull” or “hard inquiry“. 

Taking out a new loan, like a home equity loan or HELOC, will also increase your debt load, which could hurt your credit score. However, on the other hand, if you make timely payments every billing period, it may help your credit score. That’s because payment history often holds significant weight when it comes to your credit score. So, every on-time payment you make toward repaying your home equity loan may help increase your credit score.

But of course, the opposite is also true: if you miss your payments, your credit score could tumble. That’s why it’s important to ensure that you can keep up with your loan payments before applying for any type of credit. 

Can I Use A Home Equity Loan For A Down Payment?

You can use the funds from a home equity loan for almost any purpose, including for a down payment on a home purchase. In this scenario, you would borrow your down payment funds, and then use that money to apply for a mortgage with a different lender. 

Keep in mind that the government doesn’t let Canadians borrow their down payment from their lender if their lender is a federally regulated financial institution. So, you’d need to work with an alternative lender to borrow money for your down payment. If you choose to borrow money for a down payment through a home equity loan, you’ll have two payments to make: one to pay off your mortgage, and the other to pay off your home equity loan. 

How To Use Your Home Equity To Your Advantage

Tapping into your home equity is a great way to gain access to the funding you need. Because the equity you’ve worked hard to build acts as collateral for the loan or line of credit you applied for, you’ll be able to access more affordable rates and often better terms.

When it comes to using your home equity to borrow, it’s always in your best interest to spend the money on something that will help you save or make more money in the future. Some of the best ways to use your home equity to your advantage are:

• Renovations that will increase your home’s value – Several home improvement projects can not only update the look of your home and make it more functional, but they can also add value to your home. Some projects that tend to bring in the highest ROI include:
  • Kitchen or bathroom upgrades
  • New roof or windows
  • New additions
  • Adding a basement suite
  • Complete remodel
• Debt consolidation – If you’re carrying a few high-interest credit products, you may be paying more interest than necessary. In this case, it might make sense to take out a home equity loan at a lower rate than your highest-rate loan, and use that money to pay off all existing debt. Not only will you save money in interest, but you’ll also be left with just one loan to manage, rather than several. 

Cost Of Tapping Into Your Home Equity

Before you take out a HELOC or home equity loan, be wary of the costs associated with this financial program:

• Appraisal fees – Your home may have to be professionally appraised in order for your lender to verify its current market value. Appraisals can range anywhere from $150 to $250.
• Title search fees – A title search will verify whether or not there are any liens on the property. If there are, this may have to be dealt with before a home equity loan or HELOC is issued. A title search can cost from $250 to $500.
• Administration fee – There are admin fees associated with opening a HELOC or home equity loan, which vary quite a bit in cost from one lender to another.
• Closing fees – Closing costs range from $200 to $350 and are charged when you close your HELOC or home equity loan.
• Legal fees – You’ll need to pay for the services of your lawyer, which can run you somewhere between $500 to $1,000.

What Do You Need To Apply For A Home Equity Loan Or HELOC In Canada?

To apply for a HELOC or home equity loan, you’ll need to meet a few criteria including, but not limited to: 

• Be a Canadian citizen or permanent resident
• Be at least 18 years old
• Have good credit (the exact score needed will depend on the lender)
• Have a mortgage that’s less than 80% of your home’s appraised value 
• Have an acceptable debt service ratio (your monthly debt relative to your gross monthly income) 
• Earn a sufficient and stable income
• Be able to pass the mortgage stress test

You’ll be required to provide specific information to your lender, such as your personal information, proof of your ability to repay the loan, and information about your home. 

Do I Need To Pass A Mortgage Stress Test To Take Out A HELOC Or Home Equity Loan?

As briefly mentioned above, passing the mortgage stress test is part of the qualification criteria to get approved for a HELOC or home equity loan. This mortgage stress test requires buyers to show that they can handle higher mortgage payments based on increasing rates in the future compared to what their lender is offering. 

More specifically, you will need to prove that you would still be able to afford your mortgage under the test rate of either 5.25% or the rate your lender offers plus 2%, whichever is higher. A stress test is necessary for new mortgages and other products like HELOCs and home equity loans.

Can I Avoid The Mortgage Stress Test?

Only federally regulated lenders must put borrowers through this stress test. Alternative lenders are not as strictly regulated and have the flexibility to forgo the stress test when assessing the financial strength of borrowers. So, if you want to avoid the stress test, consider applying for a HELOC or home equity loan with an alternative lender.

You can quickly find lenders within the alternative lending sphere by conducting an online search using a loan comparison site like Loans Canada. Based on the information you provide about yourself, Loans Canada will automatically populate a list of lenders and their associated rates to help you find the best deal possible.  

Is A Home Equity Loan The Same As A HELOC?

Both a home equity loan and HELOC allow you to access your home’s equity. However, how you access the equity and how you repay the borrowed funds differs. 

With a home equity loan, you borrow a lump sum of money from your home’s equity. Then, you repay that money, with interest, in regular installment payments over a set term. 

With a HELOC, on the other hand, you apply for a line of credit. You then can borrow up to your credit limit on an as-needed basis. In this way, a HELOC is like a type of revolving credit, similar to a credit card. You borrow as much or as little as you need whenever you want and only pay interest on the withdrawn funds.

What Credit Score Do I Need For A Home Equity Loan?

Generally speaking, you need a credit score of anywhere from 620 to 680 to get a home equity loan. The exact score will depend on the lender, your income, employment, debt level, and equity in your home. 

For instance, if you have a high income, lots of home equity, and low debt levels, your lender may allow a lower credit score. But if your finances are weak, may need a higher credit score to offset the lender’s risk.

Find out what your credit score is for free by using Loans Canada’s CompareHub tool.

Additional Reading

Home Equity Loans For The Unemployed

Canada Home Inspection Checklist

Do You Need Renovation Insurance When Renovating Your Home?

Final Thoughts

A home equity loan is a unique financial tool. You can use it to access cash whenever the need to cover a large expense. But like any other type of financial program, make sure you’re financially capable of repaying what you owe to avoid any significant repercussions.

Home Equity FAQs

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.