For retirees, it can be difficult to live on fixed incomes. Other things that can aggravate retirees’ financial stress are insufficient savings, smaller pensions, and longer retirements. Because of this, several Canadian retirees are looking to tap into the equity they’ve accumulated in their home so their financial situation can be more desirable. However, they have a difficult time choosing between a mortgage and a home equity line of credit. Rest assured, we will elaborate on these two here in this article to give you a more informed decision about what’s best for you.
There are over three million HELOC accounts in Canada that have an average outstanding balance of $70,000. Mortgages are obviously used more widely in Canada than HELOCs. But, sometimes, a HELOC may be considered the better option than a typical mortgage. Let’s look into greater detail and decide where Canadians see themselves in this home equity line of credit vs. mortgage showdown.
What is a Mortgage?
A mortgage loan or simply mortgage is the original loan that a financial institution, like a bank, lends borrowers money to help them buy their house. In many cases, the bank can lend up to 80% of the house’s purchase price or appraised value. For instance, if you purchase a house that has been appraised at about $240,000, you can be eligible for a mortgage loan of approximately $192,000. This means that you’ll need to find a way to fill out the rest of the $48,000 by yourself. Other mortgages, like FHA mortgages, enable you to furnish a lot less than the usual 20% down, so long as the mortgage insurance is paid.
Mortgage interest rates can either be fixed or variable. The loan amount is repaid by the borrower along with interest over the fixed-term, with the main recurring terms being 30 or 15 years.
If you’re behind on your payments, the lender will occupy your house via a process called foreclosure. And in order to recoup the money, the lender will sell the house, typically at an auction. If this ever happens, the mortgage will take greater priority over other loans made against the house afterward, including a home equity loan, or home equity line of credit (HELOC). The first lender has to be paid completely before the subsequent lenders can get any of the proceeds from the foreclosure sale.
Home Equity Line Of Credit
In Canada, a home equity loan is a general term that can describe several types of loans where borrowers can use their home’s equity as collateral. In Canada, home equity loans offer bigger amounts and interest rates that are lower than unsecured loans, since the property is being used as collateral. Other types of benefits that come with a home equity loan include flexible repayment options. Plus, they are the only options available when unsecured loans aren’t available.
Sometimes a home equity loan can also be termed as a second mortgage. That means that besides the primary mortgage that needs to be paid out in case of a foreclosure or sale, there’s also a second mortgage that needs to be paid out after that. The amount that the people borrow depends on the amount that they’ve accumulated in the equity of their house.
Then there are home equity lines of credit, which works separately than home equity loans. It works similar to a credit card where you borrow a specific amount of your house’s equity and then slowly repay the amount after some time. They’re also similar to a second mortgage.
HELOCs are growing every year amongst Canadians. The consumers can use as little or even as much as they require, so long as they abide by their credit limit and ensure their account maintains a good standing. HELOCs also come with flexible repayment terms where borrowers are allowed to make interest-only payments outstanding balance. This means you pay interest on only the amount of equity that you use.
Like a conventional mortgage, a home equity loan is repaid over a fixed-term. Various lenders have various sets of standards about the home equity percentage they’re willing to lend. What’s more, is that the borrower’s credit also plays an essential role in this process.
Lenders will use the borrower’s loan-to-value (LTV) ratio to determine how much money they are permitted to borrow. To calculate LTV, you’ll need to first add the amount you wish to borrow to the amount you still owe your house and then divide it by the house’s appraised value. Whatever value you get, will be your LTV ratio. If you’re likely going to get a good portion of your mortgage paid down – or if the value of your house has risen considerably – you may be able to get a decent amount of loan.
In the end, you are the ultimate decider of this home equity line of credit vs mortgage Canada feud.
If you’re pretty savvy with your online searching abilities, you can also find credible HELOC aggregators to help you out.
Qualifying for a Home Equity Line of Credit
If a home equity line of credit is what you’ve decided upon, then you’ll need to do the following in order to qualify for it:
A 20% minimum equity or down payment, or
A 35% minimum equity or down payment if you decide on using a stand-alone HELOC to substitute a mortgage.
And before your lender can approve you for a HELOC, they’ll require you to have:
A good credit score
Acceptable debt levels compared to your income
Proof of stable and sufficient income
If you want to qualify for a HELOC at a bank, you’ll need to pass a “stress test.” This means that you have to prove that you’re able to afford all of the payments at an interest rate that helps you qualify, which is typically more than the original rate stated in your contract.
The stress test can also be used by credit unions and other types of lenders who aren’t federally regulated if you’re looking to apply for a HELOC. Although it’s not necessary that they should.
So to put this line of credit vs mortgage quarrel to bed, the choice ultimately falls on you. Although, if you ask us, a HELOC offers many benefits, if combined with the right strategy and financial goals. For instance, if you’re buying an investment property for a short time period and are planning to sell it later on, then a HELOC would be a much more suitable option for this thanks to its open and flexible terms.