Model house sitting on money

Home equity loan vs. home equity line of credit

We’ve all been in the situation where we look around at our sad, outdated kitchen and think “if only I had the money to make this place sparkle!” Luckily, your house has a little thing called equity which the banks will let you borrow for things like home renovations. There are two ways to get equity out of your house: home equity loans and home equity lines of credit.

Home Equity Loan

First, let’s define equity and loan-to-value ratio. Equity is the difference between the value of your house and the balance owing on your mortgage. If, for example, you own a $450,000 house and you owe $250,000, your equity is $200,000. With a mortgage of $250,000, your loan-to-value ratio is 55% – the percentage of your home’s value which is debt.

Home equity loans have another name – second mortgages. Basically, with a home equity loan, you’re taking out another mortgage on your house. Just like with a regular mortgage, you will have an amortization schedule and have to make fixed monthly payments. Interest rates vary but are consistently over 5%. If you don’t make your payments, the bank can repossess your house.

In Canada, banks will generally allow you to access 80% of your home’s equity. That means you can have a loan-to-value ratio of up to 80%. In our above example, an 80% loan-to-value ratio would be $320,000. If you took a home equity loan for the full amount, your bank would give you a lump-sum amount of $70,000.

Home Equity Line of Credit

A home equity line of credit is great for someone who needs less money, wants flexible payments or doesn’t need a lump sum payment.

With a home equity line of credit, you have access to up to 65% of your home’s equity. That means you can have a loan-to-value ratio of up to 65%. In our above example, a 65% loan-to-value ratio on $400,000 is $260,000. With an existing mortgage of $250,000, the borrower would be eligible for a home equity line of credit of $10,000. Like with a home equity loan, if you fail to make your payments on your home equity line of credit, the bank can repossess your house.

Like with any line of credit, the borrower isn’t required to take the entire amount straight away. Interest only applies when the money is borrowed, and borrowers can repay as much of the line of credit as they want, whenever they want. Interest rates on home equity lines of credit vary by lender but generally fall in the range of 3.5-4%.

With each of these home equity products, banks will ask for an appraisal of your property. This stops people from claiming their house is worth $500,000 when it’s really worth $400,000. Real estate and property tax assessments are also not valid for appraisal purposes.

Because your home will be collateral for your loan or line of credit, you’ll have to pay a real estate lawyer, just like when you first ought your home.

Both of these equity products serve different purposes. Your personal situation, how much money you need and how much interest you’re willing to pay will determine which home equity product is right for you.