HELOC, Refinance, Or Second Mortgage?

The equity you have built in your home can be used in a number of ways. Whether you are planning to pay off your high-interest debt or looking to do substantial upgrades to your home, it is natural to look to your biggest asset as a way to fund some of the bigger financial obligations in your life. If you are considering using some of your equity, there is more than one way to approach it. You can choose to take out a home equity line of credit (HELOC), a second mortgage, or you can refinance your existing mortgage.

What Is Home Equity?

The equity in your home is built as the value of your home increases and by paying down your mortgage. To calculate the equity you have in your home, you’ll have to find the difference between the value of your home and how much you still owe on your mortgage balance.

For example, if your home is currently worth 350,000 and your remaining mortgage balance is 175,000, then you’ll have 175,000 in home equity.

Learn more about home equity loans.

How Do You Borrow Using The Equity In Your Home?

As previously mentioned, you can borrow against your home equity in a number of ways. Some of the most common ways to do so are by taking out a HELOC, getting a second mortgage or by refinancing.

Watch mortgage broker Dave Johnson explain the different ways to access home equity.

Overview Of HELOC, Refinance, Or Second Mortgage

	Interest Rate	LTV Ratio/Equity Required	Funding Style
HELOC	Variable	65% to 80% LTV	Revolving credit limit, use as required
Refinance	Fixed or variable	– 80% LTV – Min 20% equity	Lump sum
Second Mortgage	Fixed or variable (rate is usually higher than your original mortgage)	– 90% LTV – Min 10% – 20% equity	Lump sum

HELOC

A HELOC is a line of credit that is secured against your home. Like a credit card, it allows you to withdraw money whenever you need up to a certain credit limit. During the draw period (usually 10 years) you’ll be able to reuse those funds as you pay it back. Moreover, during the draw period, you won’t have to pay any of the principal, just the interest. After the draw period ends, you’ll have to make regular payments on the interest and principal.

With a HELOC you’ll be able to borrow up to 65% to 80% of your home’s appraised value. Meaning you only need 20% equity in your home to get a HELOC. In addition, to qualify for a HELOC you also may need to have a minimum credit score of at least 650, although B lenders might offer more competitive solutions.

Best For

The best case in which to use a HELOC would be if you’re not sure how much your costs are going to run you. If you are conducting a renovation, costs could end up being more than you originally plan. A HELOC is a great way to make sure that you have enough money available to you without having to take out more than you actually need.

Refinance

Refinancing involves taking out a new mortgage to replace your existing one. By refinancing, you can qualify for a new rate, shorten or extend your term and apply for a mortgage that is larger or smaller than your original mortgage amount. Here are some of the common ways homeowners refinance their mortgage:

Cash out Refinancing – Cash out refinancing involves taking out a new mortgage that is larger than your old one. By doing so, you’ll be able to cash out the difference between the new and old mortgage. Homeowners typically use this form of refinancing to finance home renovations or other improvements.
Cash in Refinancing – Cash in refinancing is a much sought after solution by homeowners whose property value has declined and they now owe more on their mortgage than what their property is worth. Cash in refinancing allows homeowners to refinance their mortgage to a lower amount by bringing in their own cash.
Rate-and-Term Refinancing – This form of refinancing is the most common way to refinance. Rather than making any adjustments to your loan amount, you’re simply changing the rate and/or term of your mortgage.

Like a HELOC you only need 20% equity in your home though you can gain access to up to 80% of the value of your home. You also need to have the same credit score of at least 650 in order to qualify with an A-lender. The biggest difference between a HELOC and refinancing is in the way that interest is calculated. On a HELOC, you are only charged interest on what you pull out while a refinance charges you interest on the entire loan. You are also not necessarily going to go through your existing mortgage lender, you can also go to big banks and prime lenders to refinance your mortgage.

Best For

There are a number of reasons why you may want to refinance your mortgage. Some of the best reason to refinance is if:

Interest rates have lowered
You want to switch to a fixed or variable rate
Your credit score has improved and you’d like to qualify for a better rate
Your financial situation has changed and so you need to shorten or extend the term of your loan

However, do keep in mind, there are numerous fees and penalties involved with refinancing. It’s important to do a cost savings analysis to see if refinancing is really worth the cost.

Learn more about the different ways to access equity in your home.

Second Mortgage

A second mortgage is a loan that is secured against the equity in your home. Through it, you can borrow up to 90% of your home’s value. Meaning if you have less than 20% equity in your home, you can still get a second mortgage. Unlike refinancing, you’re not replacing your mortgage with a new one, rather you’re taking on a new loan that you pay along with your existing mortgage.

In order to qualify for a second mortgage, you’ll have to have a minimum of 10% equity in your home plus a credit score of 550-700. However, it’s important to remember that a second mortgage involves certain fees such as appraisal fees, legal fees, lender’s self-insured fees, and mortgage fees. You also have interest that accrues on the full loan. It may not seem as attractive as the other options, but it can get you the money if you need it.

Best For

A second mortgage could be beneficial to those who currently have high-interest debt and who struggle with poor credit. A second mortgage can help you consolidate your payments into one, making it more manageable and affordable. Moreover, those with bad credit can usually still qualify as the loan is secured by your home.

Additional Reading

Cost Of Borrowing Against The Equity In Your Home

Whether you refinance, get a second mortgage or take out a HELOC, there are certain administrative fees you’ll have to pay including:

Appraisal fees
Title search
Title insurance
Legal fees

In addition, depending on the borrowing option you choose you may need to pay additional fees. For example, if you decide to refinance you may incur a discharge fee, a prepayment fee, closing costs, and more. Before opting for any option, be sure to evaluate all the costs involved.

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Frequently Asked Questions

Can I borrow using my home equity if I have bad credit?

There are many alternative lenders who provide equity loans to those with bad credit. Many will base your approval on the equity in your home, your income and your debt level.

How do I calculate the equity in my home?

To calculate the equity in your home, simply find the difference in value between your home and your mortgage balance. For example, if your home is currently worth $450,000 and you have a mortgage balance of $175,000, then you’ll have $275,000 worth of equity. You can take this a step further and check your LTV ratio by dividing your mortgage balance by your home value and multiplying it by 100 (175,000/450,000 x 100 = 38.8%).

Do I need to get my home appraised for a second mortgage?

In general, lenders will require an appraisal of your home to verify the value of your property. If the appraised value is lower than what was expected, resulting in lower equity, your loan application may be denied.

Bottom Line

These were three examples that you can use to access some of the equity that is in your home. In order to know which is best for you, you have to carefully consider your situation, why you are in need of the loan, and where your current credit score sits. While one might make sense for a person with pristine credit and an exact amount of what they need to withdraw, another might make sense for someone who isn’t sure how much money they need yet, and could suffer from stiff lender rates. Consider all of these facts before settling on your loan method.

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Priyanka Correia

Priyanka is a personal finance expert at Loans Canada. She is passionate about money management and educating Canadian consumers about how to take control of their financial lives. She has taken financial control of her life by using Mint to budget and track her expenses while growing her wealth by investing through Wealthsimple. She also believes in having an emergency fund, so she keeps a good sum of money in an easily accessible high-interest savings account. She also uses the American Express Cobalt Card to earn points on all her purchases, further fueling her savings goal. She also uses Loans Canada’s lender directory whenever she wants to compare rates from different lenders.