Home Equity Loans: Turning Property Equity Into Credit

What a home equity loan is

A home equity loan converts the difference between what a property is worth and what is still owed on it into credit, secured by a charge registered against that property. That difference, your equity, is the pool the borrowing comes from. The home is the lender's fallback if you stop paying, which is why the cost is usually lower than unsecured borrowing and why the consequences of default reach further.

Two structures are sold under similar words, so ask which one you are being offered. A lump sum gives you one amount, on a set term, with a defined payment schedule and a visible end date. A line of home equity is a revolving limit you can draw from, repay and draw from again, usually with interest charged only on what is outstanding. A lump sum fits a single known cost. A line of home equity fits a cost whose size or timing is still uncertain.

At federally regulated lenders, a home equity line of credit is generally limited to 65% of appraised property value, and total secured lending against the home is usually capped at 80%. Those are ceilings, not entitlements. Your own limit comes from the lender's assessment of the property, the existing charges against it and your ability to carry the payments. Because an equity loan is secured against an asset, the property is what the lender can ultimately look to.

loanmoose.ca is not a lender. It does not make loans, set rates or make credit decisions. It is a matching and comparison service that connects consumers with licensed providers, so every term you are offered comes from the provider, not from this site.

Who it suits

• You own a home and have built equity, meaning the balance still owing on the property is well below its appraised value.
• You need a defined sum for a defined purpose, such as a renovation, a consolidation of higher-cost balances or one large planned expense.
• You can carry an additional payment alongside your existing mortgage without squeezing your monthly budget.
• Your income can be documented, whether that is salary, self-employment income or another provable source.
• You expect to stay in the property long enough for the setup costs to be worth carrying.
• You have priced unsecured borrowing first and found that its cost or its limit does not fit the job.

What a lender checks

Four areas usually decide the answer, and they are assessed together rather than one at a time.

Income. The lender wants evidence that the payment is sustainable after everything else you already owe. Salaried income is straightforward to verify; self-employment income usually requires notices of assessment and business documentation. A lender will generally look at the stability of the source, not just the total.

Existing payments. Your mortgage payment, property taxes, heating costs, any other secured charges, cards, loans and leases all count. Federally regulated mortgage lenders generally work to a total debt service ratio ceiling of roughly 44%, and they qualify an uninsured mortgage at the greater of the contract rate plus 2 percentage points and 5.25% under OSFI Guideline B-20. Insured mortgages and provincially regulated lenders are not all subject to B-20, so which test applies to you depends on who you are dealing with.

Credit file. Canada has two national credit reporting bureaus, Equifax Canada and TransUnion Canada, and a free copy of your credit report is available from each. What a provider does with what it sees is its own policy, but the file is where items such as a consumer proposal, which stays on a credit report for 3 years after completion or 6 years from filing, whichever comes first, and a first bankruptcy, which stays for 6 years after discharge, will show up.

Security. The property is the reason the loan exists, so it is examined directly: an appraisal or valuation, the balance and position of any charges already registered, the property type and location, and whether title is clear. A second charge sitting behind an existing mortgage is a different proposition for a lender than a first charge, and it is priced accordingly.

What it costs to carry

Cost has four parts, and the advertised rate is only the first of them.

Interest. This is the charge on the balance over time. A fixed rate and a variable rate behave differently: a fixed rate locks the interest portion of the payment, while a variable rate moves with its underlying benchmark, so the payment or the amortization shifts when that benchmark moves. The Bank of Canada publishes a policy interest rate, a prime rate, conventional mortgage rates and Government of Canada benchmark bond yields; these are benchmarks, not offers. Canadian fixed-rate mortgages are compounded semi-annually by law, which is worth knowing when you compare a quoted rate to a rate quoted on a different compounding basis.

Fees. Setup on a secured loan can involve an appraisal or valuation, a title search, legal work, and registration of the charge. There can also be a discharge fee when the charge comes off, and a prepayment charge if you pay the balance down faster than the terms allow or sell the property before the term ends. Ask for every fee in writing, including the ones charged later rather than at signing.

Insurance. A lender holding a charge on a home normally expects the property to be insured. Separately, you may be offered creditor insurance or a similar product tied to the loan; whether it is required or optional, what it covers and what it costs should be confirmed in writing. Default insurance is a feature of certain high-ratio first mortgages, and whether it applies to your situation depends on the loan and the lender.

Headline rate versus total cost of borrowing. A rate tells you the price of the money. The total cost of borrowing tells you what you will actually hand over across the life of the loan, once interest, fees and any insurance are counted. Over a short holding period a slightly higher rate with low fees can cost less than a lower rate with large upfront charges, and a prepayment penalty can change the arithmetic entirely. Ask for the cost of borrowing disclosure and read the penalty terms before you compare anything.

The Criminal Code sets the criminal rate of interest at 35% per year (s. 347). That is a legal outer limit on what can be charged, not a benchmark for what is reasonable, and it is not a rate you should expect to see on a secured loan.

How it compares with the alternatives

Before you sign

1. Confirm in writing which product you are being offered, lump sum or revolving limit, along with the amount, the term, whether the rate is fixed or variable, the payment, and what happens to the payment if the rate moves.
2. Ask for the total cost of borrowing across the full term with every fee itemized, and ask what the charge is if you pay it off early, refinance or sell the property before the term ends.
3. Test your own capacity: add the new payment to your existing obligations and see where your total debt service sits relative to the roughly 44% ceiling federally regulated lenders work to, remembering that an uninsured mortgage is qualified at the greater of the contract rate plus 2 percentage points and 5.25%.
4. Order your credit report from both Equifax Canada and TransUnion Canada. A free copy is available from each, and reading it before you apply gives you the chance to correct errors first.
5. Confirm who regulates the provider. Lending in Canada is licensed provincially, so the regulator and the rules differ by province and territory, and consumer complaints about federally regulated financial institutions go to the Financial Consumer Agency of Canada.