Home Equity Loan is a type of loan that allows you to borrow money against the equity in your home. It is often called a second mortgage. These types of loans usually have lower interest rates than other types of loans, making them an attractive option for many homeowners.

In this article, we’ll cover what is a second mortgage and how to use your home equity to finance home improvements, college tuition for yourself and your children and any other large expenses.

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Key Highlights

• A home equity loan is a type of consumer debt and the amount available to you will depend on your current mortgage situation.
• There are 2 types of Home Equity Loans in Canada, the fixed rate and the Home Equity Line of Credit (HELOC).
• Make sure to do your research before getting a home equity loan because if you fail to make your monthly payments, you’ll risk losing your home as your lender will sell it to recoup their loss.

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What Is a Home Equity Loan?

A home equity loan is a type of loan in which you use the equity on a house as collateral. 
What is equity on a house?  Equity is the difference between the value of your house and the amount of money you still owe to your mortgage lender.

Home equity loans are often used to get a lump sum of money without having to sell your home. It can be used to finance major expenses such as home repairs, medical bills, or college tuition.

How Borrowing on Home Equity Works

Home equity loans are loans taken out against the value of your home, meaning that you can borrow a certain amount of money based on the amount of equity you have. Generally, you must have at least 20% equity in your home before you can qualify for a home equity loan. 

The process is similar to applying for a regular mortgage meaning you’ll need to apply and qualify for the loan before getting the money. Like every other loan, you’ll have to repay it every month and so that’s very important to keep that in mind when starting the process because, in case of a problem with repayment, you’ll risk foreclosure.

Types of Home Equity Loans

There are several types of home equity loans available to homeowners.

Fixed-rate Loans

These loans give the borrower a lump sum of money, which they’ll need to repay over a set amount of years (5 to 15 years). They have a fixed interest rate and repayment term, and the money available is typically used for home renovations, college tuition, or debt consolidation. With a fixed-rate loan, you can enjoy the stability of knowing what the interest rate and monthly payment will be for the life of the loan.

Revolving Loan or Home Equity Line of Credit (HELOC)

A HELOC is a revolving line of credit secured by the equity in your home. It works like a credit card, you can withdraw whenever you need money. These lines of credit can be used to make home improvements, pay off existing debt, pay medical bills, or finance a major purchase. You’ll be required to make payments on the amount of money you actually use, and the interest rate is usually variable.

Common Uses for Home Equity Loans

A home equity loan or 2nd mortgage is a great way to access the equity you have built up in your home for various purposes. Common uses for home equity loans in Canada include debt consolidation, home renovation projects and emergency expenses.

Debt Consolidation

Home equity loans can be a good way to clear off credit card debt, personal loans and store cards, by consolidating all your debt into one debt. This new debt will cover all your debt as well as corresponding fees and you’ll probably end up paying less interest rather than paying them separately.

Home Renovations

Home equity loans can be a great way to finance larger renovation projects in your home such as renovating an outdated kitchen, replacing a leaky roof or adding an extra bedroom to your home. These will also increase the overall value of your property.

Emergency Expenses

Home Equity Loans, especially HELOC, can be used in case of a financial emergency. It can be used for unexpected medical fees if your car breaks down and needs a replacement urgently or to cover any expenses that you had not anticipated.

How to Get a Home Equity Loan

As we saw above there are different types of loans but also different ways to get a home equity loan. To get started, you’ll need to first check your credit score to make sure you’re eligible for a loan. You’ll then need to shop around for the best lender and loan terms that work for your budget. Here are some alternatives to consider.

Refinancing

The first way to use your home equity is to refinance your home by borrowing up to 80% of the estimated value of your home. When you refinance your mortgage, you’ll get a new mortgage agreement for a higher amount than your first mortgage. It’s even more interesting if you manage to get a lower interest rate compared to the one when you got your first mortgage.

Home Equity Line of Credit (HELOC)

As we saw, you can use your home equity to get a Home Equity Line of Credit (HELOC).

It allows you to borrow money against the equity you have in your home and you will repay only the money that you use plus the interest.

Reverse Mortgage

A reverse mortgage is a financial tool that allows homeowners 55 and older to convert a portion of their home equity into cash. With a reverse mortgage, you’ll be able to borrow up to 55% of the value of your home.
A reverse mortgage can provide a financial boost for older homeowners who need extra money to cover expenses, pay off debt, or make home improvements.

Home Equity Loan Requirements

Generally, mortgage providers will ask you to have a good credit score and sufficient income to cover the loan’s monthly payments. You will need to have a minimum amount of equity in your home, usually around 20%. 

Example of a Home Equity Loan (Calculation)

Borrowing on home equity is a great way to access the equity you have built up in your home, let’s look at an example of a home equity loan.

Home equity loans in Canada are typically 80% of your home equity minus the rest of the mortgage that you still owe to the lender.

For example, if the market value of your home is $400,000 and you still owe $200,000 on your current mortgage balance.

$400,000 x 0.80 = $320,000

$320,000 – $200,000 = $120,000

You’ll be able to apply for a loan of up to $120,000.

How to Build Home Equity

Building home equity is a great way to increase your financial security and wealth. Here are some tips to help you build home equity before applying for a home equity loan: 

Equity builds when your property value rises

Take advantage of home value increases. As the value of your home increases, your home equity increases as well.

Make improvements on your home to increase your properties value

Any improvements, extensions or renovations you make to your home can increase its value.

Making payments on your mortgage amount (reducing balance allows you to build equity)

Paying extra on your mortgage each month can help you build home equity faster.

Making a larger down payment

If you can afford to make a larger down payment when you buy your home, this will be the fastest way to build equity on your property.

Home Equity Loans vs. HELOCs

When it comes to choosing between a home equity loan and a Home Equity Line of Credit (HELOC), it’s important to understand the differences between them. 

Home Equity Loans	HELOCs
Up to 80% of your home’s market value minus the balance of your first mortgage	65% to 80% of your home’s market value minus the balance of your first mortgage
Lump sum of money	Revolving lines of credit
Fixed rate and set term	Repayment will depend on the money used

FAQ

Final thoughts

The best choice of home equity loan will depend on your individual circumstances and financial goals. Consider your current and future needs, how much money you need, how you plan to use it, and how quickly you need access to the funds. Doing your research and understanding the differences between the various types of loans will help you make the right decision for your situation. If you need financial guidance regarding these types of decisions, contact one of nesto’s advisors, they will be able to help you find the best solution for your situation. 

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