The home equity loan:
What it is and how it works

You can use home equity for paying debts, home renovations, or even to finance your child’s education

November 24, 2021

The home equity loan

If you own a home in Canada, this article can help you better understand how your home equity loan will work. But before that, you must know what a home equity loan is. You can get your home’s equity, which is a form of credit, and use it for paying down debt, home renovations, or even to finance your child’s college education.

What it is

It’s a second mortgage. It means that you borrow against the equity in your home. The equity in one’s home is the difference between how much one’s house is currently worth and what one owes on one’s mortgage or any other debt that your home secures. If you can’t pay your loan back, the lender can foreclose on your property.

How will your home equity loan work?

Your home serves as collateral with a home equity loan. The home equity loan is a secured loan that makes you qualify for a lower interest rate. As compared to other forms of credit such as a personal loan, it will be easier to acquire. 

How much can you borrow with a home equity loan?

It depends on your credit history, the amount of equity you have in your home and how much of your monthly income is available to repay a loan. Though other lenders might have stricter limits, you’re generally limited to borrowing 85% of the equity in your home. For example, if your equity was $100,000, the maximum you could borrow would be $85,000. 

How to qualify for a home equity loan?

Both going through the process for a new mortgage and getting approved for a home equity loan are somewhat the same. Your lender reviews your application along with your credit score, your home’s equity, credit report, and debt-to-income (DTI) ratio.

Though approval criteria can differ from one lender to the other, the following are the basic requirements you need to fulfill to qualify for a home equity loan:

• Credit Score
  The higher you score, the lower your interest will be. But generally, you need a credit score of at least 680 to qualify for most home equity loans. Moreover, if the credit score is 660, you might get a loan but chances are you will end up with a higher interest rate.

• Debt-to-income ratio (DTI ratio)
  What is the DTI ratio? The percentage of your monthly income that goes towards debt payments is your DTI ratio. Moreover, the ratio also includes your mortgage, credit cards, car payment, and student loans. There’s one thing that you need to take care of: your DTI ratio shouldn’t exceed 43% when applying for a home equity loan.

• Equity
  You need to have at least 15% to 20% equity in your home to qualify for a home equity loan. For example, your home’s equity is $50,000, or 20% if your house is worth $250,000 and you owe $200,000 on your mortgage.

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