Are you a Canadian homeowner looking to tap into your home equity? Are you trying to decide between Home equity loans or Home equity lines of credit (HELOC)?
You’re not alone! With rising home values across Canada, many homeowners leverage their equity to finance renovations, consolidate debt, or access funds for other significant expenses.
But how do you know whether a Home equity loan or HELOC is better for your situation?
This comprehensive guide will explain everything you need to know about Home equity loan vs HELOC in the Canadian market. By the end, Canadians will have a clear understanding of these two popular ways to access home equity and be able to decide which is the right fit.
How Do Home Equity Loans and HELOCs Work?
Let’s look at how home equity loans and HELOCs work.
Home Equity Loans Overview
A home equity loan leverages the equity in your home to provide funds in a single lump-sum payment.
With a home equity loan:
- You receive the full loan amount upfront as a one-time payout
- The interest rate is fixed for the term of the loan (often 5-20 years)
- You make regular monthly payments of principal + interest over the loan term
- The monthly payments stay the same over the full repayment period
Essentially, a home equity loan provides homeowners with a set amount of cash upfront that is repaid in predictable installments over a defined period.
HELOCs Overview
A home equity line of credit (HELOC) also taps into your home equity but works slightly differently than a loan.
With a HELOC:
- You have access to a revolving line of credit up to a set limit
- You can withdraw funds as needed until the draw period ends (usually 10 years)
- During the draw period, you make flexible payments, often interest-only
- Once the draw period ends, you enter the repayment period (usually 20 years)
- During repayment, you make principal + interest payments on any outstanding balance
In short, a HELOC provides the flexibility to access funds as needed, with payments that can adjust over time depending on the outstanding balance.
Key Differences Between Home Equity Loans and HELOCs
Home equity loans and HELOCs differ in several ways, including Interest rates, How you receive your money, Loan Term Structure, Payment Flexibility, and Costs.
Interest Rates
Home Equity Loan: This loan has a fixed interest rate that stays the same throughout the loan term, fees and closing costs.
HELOC: Typically offers a variable interest rate that can fluctuate over time.
This is a key distinction. With a home equity loan, you lock in an interest rate upfront, which provides certainty about the total cost of borrowing. A HELOC’s rate adjusts based on market conditions, so your exact costs are less certain.
Over the long run, a lower initial HELOC rate may cost more if the prime rate rises significantly. Or it may stay lower than a home equity loan if the prime holds steady. It’s impossible to predict.
For example, if you received a home equity loan with a 5% fixed rate, your rate would stay at 5% for the entire term, even if market rates rose to 6% or 7%. With a HELOC, your variable rate could increase with market rate hikes.
However, HELOCs often start with lower introductory interest rates, which can mean lower costs in the short term if you pay off the balance quickly.
How You Receive Funds?
Home Equity Loan: Provides the full approved loan amount as a lump-sum payment.
HELOC: Gives access to a line of credit you can draw from as needed.
This difference comes down to flexibility. A home equity loan gives you a set amount all at once, while a HELOC allows you to access smaller sums over time.
So, if you needed $50,000 to renovate your kitchen, a home equity loan would provide the full $50,000 upfront. With a HELOC, you could withdraw $5,000 now for demolition, another $10,000 next month for cabinets, and so on.
Loan Term Structure
Home Equity Loan: Typically a term of 5-20 years. You repay principal + interest in fixed monthly payments over the term length.
HELOC: Divided into a draw period (typically ten years) and repayment period (typically 20 years). Payments work as follows:
- Draw Period: Make flexible payments, often interest-only, and can access funds as needed.
- Repayment Period: Make principal + interest payments on any outstanding balance until fully repaid. No longer have access to draw additional funds.
A HELOC offers more flexibility during the draw period, while a home equity loan provides predictable payments spread evenly over the full term.
Payment Flexibility
Home Equity Loan: Fixed monthly payments of principal + interest. The payment amount does not change.
HELOC: Your payments can be adjusted based on your outstanding balance and whether you are in the draw or repayment period.
A HELOC provides more cash flow flexibility, especially if you don’t need to access the whole amount up front. Home equity loan payments stay fixed, which creates predictable cash flow.
Upfront and Ongoing Costs
Home Equity Loans often come with higher upfront costs, including:
- Origination fees
- Application fees
- Appraisal fees
- Legal and title fees
- Other closing costs
These combined costs often total 2-5% of the total loan amount. For example, on a $50,000 home equity loan, you may pay $1,000 to $2,500 in upfront costs. [Source]
HELOCs tend to have lower or no upfront costs. Some lenders waive application and origination fees. You may pay appraisal and legal fees, often lower than home equity loans. However, HELOCs frequently have annual maintenance fees.
Aside from upfront and interest costs, watch for these other fees:
Prepayment Penalties: Home equity loans sometimes charge penalties if you pay off the balance early, while HELOCs typically don’t.
Draw Fees: Some lenders charge small fees (e.g., $50) each time you withdraw funds from a HELOC.
Early Closure Fees: HELOCs may charge fees if you close the line of credit before the draw period ends.
Compare all rates and fees carefully before choosing the right option.
Security and Risks
For both home equity loans and HELOCs, your home acts as collateral for the loan. If you default on payments, the lender can foreclose on your home. This is the major risk to understand up front when tapping home equity.
HELOCs may come with a bit more risk since payments are flexible. Extending the interest-only period and minimum payments can be tempting, meaning you accumulate more debt over time. Home equity loans have fixed payments spread over the term, which creates more payment discipline.
Pros and Cons of Home Equity Loans and HELOCs
Home Equity Loan Pros and Cons
Pros | Cons |
– Receive funds as a lump sum – Fixed interest rates and payments – Predictable monthly payments – You may be able to deduct interest (check with an accountant) | – Higher interest rate than HELOCs – Less flexible than HELOC – Large upfront fees and closing costs – Risk of foreclosure if payments are missed |
HELOC Pros and Cons
Pros | Cons |
– Access funds as needed from the line of credit – Typically lower initial interest rate – Flexible payment options, often interest-only – Only pay interest on what you use | – Interest rates can fluctuate over time – Risk of accumulating more debt/overusing funds – Risk of foreclosure if payments are missed – Temptation to extend interest-only period |
Which Is Better: Home Equity Loans or HELOCs?
So when should you choose a home equity loan or HELOC? Here are some key factors to consider:
Do You Need a Lump Sum or Flexible Access?
A home equity loan is a good option if you need a large lump sum for a major one-time expense, such as home renovations or purchasing a car.
HELOCs are a good option if you have ongoing expenses that will arise over months or years. They allow you to access smaller amounts as needed.
What Are You Using the Funds For?
Home equity loans may be better for large expenses like renovations or consolidating higher-interest debt. Predictable payments can help with budgeting.
HELOCs may be preferable for unpredictable costs like emergency home repairs or a child’s education. They offer flexible access to funds as needed.
What Is Your Risk Tolerance?
Home equity loan provides payment certainty since the rate and term are fixed. This can be less risky for borrowers who worry about managing fluctuating payments.
HELOCs offer flexible payments, but rate and payment changes over time bring uncertainty. They are a better match for risk-tolerant borrowers.
What Are Your Repayment Plans?
Home equity loan structured payments make it easier to plan full repayment over a set term.
HELOC flexibility means discipline is required to avoid extending interest-only periods and delaying full repayment.
In summary:
- Home equity loans provide lump sum cash injections but less flexibility
- HELOCs provide customizable cash flow but uncertain rates/payments
Speak to a mortgage broker or advisor to determine the right fit based on your financial situation and plans.
Alternatives to Home Equity Loans and HELOCs
Beyond traditional home equity loans and HELOCs, also consider these alternatives for accessing home equity:
Mortgage Refinancing
Some homeowners opt to refinance their mortgage and withdraw equity during the process. This avoids HELOC/second mortgage costs. Refinancing works best if primary mortgage rates have dropped significantly from when you originated the loan. This allows you to withdraw equity at lower rates. Discuss with your mortgage broker.
Reverse Mortgage
Reverse mortgages allow seniors (55+) to withdraw equity without monthly payments. You retain ownership; the loan is repaid when you leave or move out. This can supplement retirement income but comes with high upfront costs.
Personal Loans or Lines of Credit
Borrowing against home equity isn’t the only option. Sometimes, a personal loan or line of credit may cost less and pose less foreclosure risk. Compare rates and fees first before pursuing home equity options.
Key Takeaways – Home Equity Loan vs HELOC in Canada
Let’s review the key differences between Home equity loans and HELOCs in Canada.
Home Equity Loans
- Receive funds as a one-time lump sum
- Come with a fixed interest rate
- Have fixed monthly principal + interest payments
- Terms range from 5-20 years
- Require large upfront closing fees of 2-5%
HELOCs
- Provide access to a revolving credit line
- Have adjustable interest rates
- Offer flexible payments, often interest-only
- Have a 10-year draw period and 20-year repayment period
- Tend to have low or no upfront fees
While both can provide favourable rates compared to other financing options, consider upfront costs, long-term flexibility in payments, whether you need funds all at once or over time, risk tolerance, and planned use of funds.
This will help determine if a home equity loan or HELOC better matches your financial situation.
Ready to Move Forward?
The mortgage brokers at Best Mortgage Online will evaluate your financial objectives, crunch the numbers, and recommend the most strategic way to leverage your home’s hard-earned equity.
Don’t leave money on the table. Tap into your home’s potential with the right loan option today.