Home Equity Loan FAQs: Definitions & Basics in Canada

Navigating the world of home equity loans in Canada can be complex. As an award-winning mortgage brokerage with over 2,000 five-star reviews since 2015, 360Lending has created this comprehensive three-part FAQ to guide you.

This first part breaks down the Definitions and Basics of home equity loans. Some of the questions below link to a more in-depth article, giving you the option to dive deeper into the topics that matter most to you.

Once you have a foundational understanding, you can explore our other guides on Home Equity Loan FAQs: Requirements and Lenders and Home Equity Loan FAQs: Costs, Benefits & Uses to continue your journey.

What Is Home Equity and How Is It Defined?

Home equity is the difference between your home's current market value and the amount you owe on your mortgage. You can build equity by making mortgage payments, having your property's value increase, or a combination of both.

Think of it as the portion of your home that you truly own, free and clear of any debt. Your home equity is an asset that grows over time and can be leveraged to achieve your financial goals without needing to sell your property.

How to Calculate Your Home Equity?

To calculate your home equity, simply subtract your outstanding mortgage balance from your home’s current market value. For example, if your home is valued at $500,000 and your mortgage balance is $300,000, you have $200,000 in home equity.

It’s important to note that a formal home appraisal may be required to determine your home’s most accurate current market value. While online estimators can give you a rough idea, a professional appraisal is what a lender will rely on when evaluating your equity.

What Is the Loan-to-Value (LTV) Ratio?

The loan-to-value (LTV) ratio is a financial metric used by lenders to determine the risk of a loan. It is calculated by dividing the mortgage amount by the appraised value of the property. A lower LTV ratio signifies less risk for the lender.

For example, if you have a $300,000 mortgage on a $500,000 home, your LTV ratio is 60% ($300,000 ÷ $500,000). Lenders use this ratio to understand how much equity you have and to set their lending limits.

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Can You Access Home Equity Without Refinancing?

Yes, you can. The most common ways to access your home's equity without refinancing are through a Home Equity Line of Credit (HELOC) or a home equity loan. Both of these options allow you to borrow against your home's value while keeping your existing primary mortgage in place.

What Are The Different Ways to Borrow Against Your Home Equity?

There are three main ways to borrow against home equity in Canada: a Home Equity Line of Credit (HELOC), a home equity loan, or a cash-out refinance. A HELOC is a flexible, revolving line of credit. A home equity loan is a one-time lump-sum loan. A cash-out refinance replaces your existing mortgage.

How Much Can You Borrow Against Your Home in Canada?

In Canada, you can typically borrow up to 80% of your home's appraised value when using your equity for a home equity loan or a HELOC. This is a common limit set by major lenders to ensure a buffer for market fluctuations.

This 80% limit is based on your total debt against the home, including your first mortgage. Your specific borrowing amount will depend on your financial situation, including your credit score, income, and overall debt-to-income ratio. Lenders have to ensure that your total borrowing does not put you at a high risk of default.

What Is a Home Equity Loan?

A home equity loan is a type of second mortgage that allows you to borrow a lump sum of money using the equity in your home as collateral. The loan is typically repaid over a fixed term with a fixed interest rate.

Unlike a line of credit, a home equity loan provides a single infusion of cash. This makes it an ideal choice for borrowers who have a specific, one-time need for a large amount of money, such as for a major renovation or to consolidate all their high-interest debt into a single payment.

How Does a Home Equity Loan Work?

A home equity loan works by providing you with a single, lump-sum payment that is secured by your home. You repay this amount in fixed monthly installments over a set period, similar to a traditional mortgage.

The loan itself is separate from your primary mortgage. This means you will have two separate loan payments each month: one for your first mortgage and a second for your new home equity loan.

Is a Home Equity Loan a Second Mortgage?

Yes, a home equity loan is a type of second mortgage. It is a separate loan that uses your home as collateral and is subordinate to your primary mortgage, meaning your first mortgage is the first to be repaid in case of a default.

This subordination is an important distinction. In the event of a sale or foreclosure, the first mortgage lender is paid back in full before the second mortgage lender receives any funds. This is why second mortgages often come with slightly higher interest rates than primary mortgages, as they carry more risk for the lender.

What's the Difference Between a Home Equity Loan vs. HELOC?

A home equity loan is a lump-sum loan with a fixed interest rate and a set repayment schedule, ideal for a single, large expense. A HELOC (Home Equity Line of Credit) is a revolving line of credit with a variable interest rate, which allows you to borrow as needed and only pay interest on what you use.

What's the Difference Between a Home Equity Loan vs. Cash-out Refinance?

A home equity loan is a second loan that leaves your primary mortgage untouched. A cash-out refinance, however, replaces your existing mortgage with a new, larger one, and you receive the difference in cash.

The main consequence of a cash-out refinance is that it resets the term of your first mortgage, which may mean paying more interest over the long term. A home equity loan is a separate product, and it will not affect the interest rate or terms of your primary mortgage.

How Does a Home Equity Loan Compare to a Personal Loan?

A home equity loan is a secured loan that uses your home as collateral, typically resulting in a lower interest rate. A personal loan is an unsecured loan, which carries a higher interest rate but does not put your home at risk.

Because your home serves as collateral, home equity loans are generally considered less risky for a lender, allowing them to offer a more competitive interest rate. A personal loan is based solely on your creditworthiness, which is why it often comes with a higher cost of borrowing.

What Are Common Uses for a Home Equity Loan?

Common uses for a home equity loan include debt consolidation, home renovations, paying for major life expenses such as education or medical bills, and making large purchases like a vehicle.

Home equity loans are especially useful for one-time, significant expenses where you need a predictable, large infusion of cash. The fixed rate and fixed term make it easy to budget for the repayment over time.

Are Home Equity Loans Tax-Deductible in Canada?

In Canada, the interest on a home equity loan is not tax-deductible for personal use. However, it may be tax-deductible if the funds are used for a qualified investment or to generate income from a business or rental property.

This is a key consideration for borrowers. While the interest on a home equity loan is not tax-deductible if you use the funds for a car or a vacation, the rules are different if you use the money for an investment property or a business. Always consult with a financial advisor to understand the tax implications of your specific situation.

Home Equity Loan Definitions & Basics in Canada

This guide has provided a foundational understanding of home equity loans. To learn more, explore our other comprehensive guides on Home Equity Loan Requirements & Lenders and Home Equity Loan Costs, Benefits & Uses.

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