How Home Equity Loans Work

home can be a source of great pride and satisfaction, and if you're looking to finance a renovation, a new vehicle or some unforeseen emergency, it can also be a source of equity. A home equity loan allows you to leverage your property's equity - i.e. the difference between the home's appraised market value and your outstanding mortgage balance - to secure a loan.

Why do people opt for home equity loans? Simply put: the interest is lower. Credit card rates currently hover around 17 percent. A home equity loan or line of credit, on the other hand, can range from the prime business rate set by the Bank of Canada, known simply as "prime" (currently 4.25 percent), to prime-plus-three (which would be 7.25 percent). The rate for a home equity loan is often better than that for a personal line of credit. The rate you get will depend on your credit history, your earnings and whether you have existing assets with a particular lending institution.

Home equity loan vs. home equity line of credit

The difference between a home equity loan and a home equity line of credit is that with a loan, once you've used a percentage of the loan, you won't be able to access it again. For example, if you took out a $5,000 loan to fund a vacation, whether you've repaid a fraction or the entire sum, you have to re-apply to get another loan. With a home equity line of credit, once you've used it, you can spend as much as you've paid back. If you used $8,000 and repaid $5,000, you have access again to $5,000.

Given the reduced interest, many people use a home equity loan to consolidate their debts. They utilize it to settle their other arrears (credit cards and lines of credit) and combine their entire debt load and refinance it at one reasonably low interest rate.

The home equity loan or line of credit must be tied to your principal residence; banks don't normally secure such loans to rental properties. The loan is generally repaid in monthly installments, and must be entirely settled when you move out of the house.