Mortgages versus home equity loans: What’s the difference and which is the best option?
Mortgages and home equity loans are among the most popular ways to borrow money in Manitoba and across Canada. Around 40% of Canadians have a mortgage and over three million have a home equity line of credit (HELOC). In Manitoba, only 42 to 46% of homeowners have paid off their mortgages.
However, some Canadians struggle to manage these loans adequately. Around a quarter of HELOC holders are carrying a balance of over $150,000, and a similar percentage make only monthly interest payments, while thousands of mortgages are in arrears each year.
It can be tricky to know which financing option is right for you, and many borrowers wonder when it comes to a home equity line of credit vs. a mortgage, which is better? We examine
mortgages, HELOCs and home equity loans and suggest which circumstances they’re best suited to, so you can make the right homeownership decisions.
Mortgages and home equity loans: how they’re similar
Mortgages and home equity loans have a fair amount in common: they’re both loans that are secured against your home. What that means is, if you fall behind in payments, the lender could force the sale of your home to pay the debt.
The maximum amount your lender will provide will depend on calculations called debt service ratios. These take into account your income compared to your outgoings (your mortgage and all other debts) and lenders will only lend up to a certain percentage. This is the case for both a mortgage and a home equity loan: lenders need to be certain that you can afford to pay back your loan.
Financial institutions will also take into account the home’s value compared to the loan amount (the loan-to-value ratio). Most will only lend a maximum of 80% of the home’s value (unless it’s for a home purchase, in which case they may go as high as 95%, but the buyer would have to take out mortgage loan insurance).
New mortgages, refinanced mortgages (where you increase the amount of money you secure against your home) and any kind of home equity loan all typically have additional costs involved. Usually these include legal fees, title search/insurance and an appraisal (to confirm the value of your home). Renewed mortgages (where you sign on for a new term but keep the same size of loan) require no extra costs.
Now that we’ve looked at the similarities that the home equity loans share, let’s take a look at the pros and cons of each one.
The benefits and downsides of mortgages
The main difference between a mortgage and a home equity loan secured against your home, is that the loan is typically a much smaller amount and is usually paid off much sooner than your mortgage.
The main advantage of mortgages is that they allow you to borrow a lot of money, which is just as well, with home prices in Canada going through the roof. Also, if you have good credit, mortgage interest rates are among the lowest you’ll find for any kind of loan in Canada. (You can check out our up-to-date rates here).
The main disadvantage of a mortgage vs. a home equity line of credit or HELOC, is its lack of flexibility. You have to make regular interest and principal payments, usually every month or two weeks, until the mortgage is paid off. You do have flexibility to pay more than the usual payment, up to a certain extent (typically between 15 to 20% extra per year). However, you can’t pay less than your usual amount.
When a mortgage might be your best option:
When you’re buying a home, or if you want to refinance, to cash in some home equity, provided that you’re comfortable adding the extra loan amount to your mortgage.
The pros and cons of a HELOC
There are several key benefits to having a HELOC, when compared to a mortgage. One of its biggest draws is that it provides a rolling line of credit, much like a credit card. Once you pay off an amount, that becomes immediately available to you again.
Some other advantages of a home equity line of credit vs a mortgage in Canada include:
- You can use the money for any purpose, at any time.
- If you don’t borrow any of the available money, you won’t pay any interest.
- It’s extremely flexible: you can choose to pay off just the monthly interest, the whole amount or anything in-between.
- Interest rates are usually much lower than unsecured loans.
- This flexibility makes them perfect to finance on-going projects, such as home renos.
- If you haven’t saved up an emergency fund, a HELOC can be used for unexpected expenses.
There are, however, a few potential downsides of a home equity line of credit vs. a mortgage:
- It can be very easy to rack up a lot of debt (remember that a quarter of Canadian HELOC holders have borrowed over $150,000).
- Without a solid plan it can take a very long time to pay off.
- Interest rates are typically higher than with a regular mortgage.
- Interest rates are variable, so they could rise at any point. This can make budgeting more difficult.
What are the differences between a HELOC and a home equity loan? Learn more on that in the next section.
When a HELOC might be your best option:
When comparing a home equity line of credit vs. a mortgage, which is better if you’ll need access to fairly large sums of money over a period of time? In this instance, a HELOC is usually the wisest option. You only have to apply for it once and can then draw as much as you need, on numerous occasions, for any purpose. You should have a realistic plan to pay off what you owe, however, otherwise your HELOC could become a huge financial burden.
The advantages and disadvantages of home equity loans
What is a home equity loan, exactly? Well, it’s similar to a HELOC, in that it is a loan secured on your home. But unlike a HELOC, there will be a defined repayment period. This means your debt will be repaid in full within an agreed number of years. You’ll have regular (usually monthly) repayment amounts that include principal and interest, much like with your mortgage. This also makes home equity loans easier to budget, as those amounts don’t tend to change.
What is a home equity loan’s main downside? It’s not as flexible as a HELOC, so you can’t make interest payments only, if finances are tight in any given month. Another disadvantage is that you pay interest on the full amount from the get-go. And a crucial difference between a mortgage and a loan secured against your home is that interest can be higher with a loan than a mortgage.
When a home equity loan might be your best option:
If you’re certain you’ll be able to make the rigid monthly payments, a home equity loan can be an excellent option to pay for one-off, big-ticket expenses. These could be for a wedding, a new kitchen or bathroom, or even to pay off your high-interest credit card debt.
Discuss your options
If you’re still not sure which loan is right for you, an ACU financial advisor will happily discuss all the options with you. They’ll be able to help you figure out whether a mortgage or home equity line of credit will make the most sense for your situation and help you with the application process.
Still not sure which loan is right for you? Let an ACU financial advisor help! We are able to help you determine which borrowing option makes the most sense for you, and also help you with the application process. Book an appointment online today.
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