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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.

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You can apply without affecting your credit score.

What Is A Second Mortgage In Canada?

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: ibeloan.com 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 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).

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.

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How Will a Home Equity Loan Affect My Credit Score?

Applying for new credit, such as a home equity loan, can impact your credit score. This is because lenders perform a "hard pull" or "hard inquiry" on your credit file to evaluate your creditworthiness.

Taking out a home equity loan or HELOC increases your overall debt, which might negatively affect your credit score. However, making timely payments can positively influence your score, as payment history is a significant factor in credit scoring. Consistently paying on time can help improve your credit score over time.

Conversely, missing payments can harm your credit score. Therefore, it's crucial to ensure you can manage the loan payments before applying for any new credit.

Can I Use a Home Equity Loan for a Down Payment?

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

However, it's important to note that the Canadian government does not allow borrowers to use funds from a federally regulated financial institution for their down payment. Therefore, you would need to work with an alternative lender to borrow money for your down payment.

If you decide to use a home equity loan for a down payment, remember that you will have two separate payments to manage: one for your mortgage and another for your home equity loan.

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.

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 to Use Your Home Equity to Your Advantage

Accessing your home equity can be an excellent way to secure the funds you need. Since the equity you've built up serves as collateral for the loan or line of credit, you can often benefit from more favorable rates and terms.

To make the most of your home equity, it's wise to invest the money in ways that will help you save or generate more income in the future. Here are some effective strategies:

Renovations to Increase Home Value

Investing in home improvements can not only enhance the look and functionality of your home but also increase its value. Projects with the highest return on investment (ROI) include:

Kitchen or Bathroom Upgrades
New Roof or Windows
New Additions
Adding a Basement Suite
Complete Remodel

Debt Consolidation

If you have multiple high-interest debts, you might be paying more in interest than necessary. Using a home equity loan at a lower interest rate to pay off these debts can save you money and simplify your finances by consolidating multiple payments into one.

By strategically using your home equity, you can improve your financial situation and potentially increase the value of your home.

Costs of Accessing Your Home Equity

Before taking out a HELOC or home equity loan, it's important to be aware of the associated costs:

Appraisal Fees: Your home may need a professional appraisal to verify its current market value, typically costing between \$150 and \$250.
Title Search Fees: A title search checks for any liens on the property, which must be resolved before issuing a loan. This can cost between \$250 and \$500.
Administration Fees: There are administrative costs for opening a HELOC or home equity loan, which vary by lender.
Closing Fees: These 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 legal services, which can range from \$500 to \$1,000.

Understanding these costs can help you better prepare for the financial commitment involved in accessing your home equity.

Requirements for Applying for a Home Equity Loan or HELOC in Canada

To apply for a Home Equity Line of Credit (HELOC) or a home equity loan in Canada, you need to meet several criteria, including:

Be a Canadian citizen or permanent resident
Be at least 18 years old
Have a good credit score (specific requirements vary by lender)
Have a mortgage balance that is less than 80% of your home's appraised value
Maintain an acceptable debt service ratio (your monthly debt payments compared to your gross monthly income)
Have a stable and sufficient income
Pass the mortgage stress test

When applying, you'll need to provide your lender with certain information, such as your personal details, proof of your ability to repay the loan, and information about your home.

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Do You Need to Pass a Mortgage Stress Test for a HELOC or Home Equity Loan?

Yes, passing the mortgage stress test is a crucial part of qualifying for a Home Equity Line of Credit (HELOC) or a home equity loan in Canada. This test ensures that you can manage higher mortgage payments if interest rates rise in the future.

Specifically, you must demonstrate that you can afford your mortgage at the test rate, which is either 5.25% or your lender's rate plus 2%, whichever is higher. This stress test is required for new mortgages as well as HELOCs and home equity loans.

Can You Avoid the Mortgage Stress Test?

Only federally regulated lenders are required to conduct the mortgage stress test. Alternative lenders, who are not as strictly regulated, have the flexibility to skip this test when evaluating borrowers' financial strength. Therefore, if you want to avoid the stress test, consider applying for a HELOC or home equity loan with an alternative lender.

You can easily find alternative lenders by using a loan comparison site like Loans Canada. By providing your information, Loans Canada will generate a list of lenders and their rates to help you find the best deal.

Is a Home Equity Loan the Same as a HELOC?

Both a home equity loan and a Home Equity Line of Credit (HELOC) allow you to access your home’s equity, but they differ in how you access and repay the borrowed funds.

With a home equity loan, you borrow a lump sum of money from your home’s equity and repay it, with interest, in regular installments over a set term.

With a HELOC, you apply for a line of credit and can borrow up to your credit limit as needed. A HELOC functions like revolving credit, similar to a credit card. You can borrow as much or as little as you need and only pay interest on the amount you withdraw.

What Credit Score Do You Need for a Home Equity Loan?

Generally, you need a credit score between 620 and 680 to qualify for a home equity loan. The exact score required will depend on the lender, as well as your income, employment status, debt level, and the amount of equity in your home.

For example, if you have a high income, significant home equity, and low debt levels, a lender might accept a lower credit score. Conversely, if your financial situation is weaker, you may need a higher credit score to mitigate the lender’s risk.

Both a home equity loan and a Home Equity Line of Credit (HELOC) allow you to access your home’s equity, but they differ in how you access and repay the borrowed funds.

With a home equity loan, you borrow a lump sum of money from your home’s equity and repay it, with interest, in regular installments over a set term.

Home Equity FAQs

Can you access your home equity without refinancing?

Yes, you can tap into your home equity without refinancing by opting for a Home Equity Line of Credit (HELOC) or a home equity loan. A HELOC acts as a revolving line of credit, while a home equity loan provides a lump sum that is repaid through fixed installments.

How much equity will I have after one year?

The amount of equity you’ll have after one year depends on various factors, including:

The size of your down payment
The amount and frequency of your mortgage payments
The portion of your payments applied to principal versus interest
Any additional prepayments made
Changes in the market value of your home

What are the requirements to qualify for a HELOC?

Qualifying for a HELOC generally requires:

A minimum of 20% equity in your home
A low debt-to-income ratio
A strong credit score

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What happens if I can’t make my payments?

If you fail to make payments on your HELOC or home equity loan, your home is at risk. Since these loans are secured by your property, the lender can repossess and sell your home to recover the debt. Any remaining proceeds from the sale, after covering the loan balance and fees, will be returned to you.

Will my home need to be appraised to get a HELOC?

Yes, a property appraisal is required to access your home equity through a HELOC or home equity loan. The appraisal determines your home’s current market value, helping the lender calculate the maximum amount you can borrow.