Home equity loans are bank products where the bank, finance companies or sub-prime lender lends you money against the portion of your home you still own after taking on a mortgage. As an example, if after evaluation the bank determines that your home is worth $500,000 and you have a mortgage of $450,000, the bank will take your portion of the home (called equity) to be $50,000. Home equity loans also go by the terms “refinancing a mortgage” and “getting a second mortgage”.
If you are looking to consolidate your debt, you can use your home equity loan to ‘buy off’ smaller loans. This gives you unparalleled convenience since you will only have one monthly repayment to make.
A home equity loan for purposes of debt consolidation should not be confused with a home equity line of credit (HELOC). A home equity loan is a lump-sum loan while a HELOC is a revolving credit that has an adjustable interest rate.
To qualify for a home equity loan, the Loan to Value ratio (mortgage value/property value) should not be more than 80% (or more than 90% if you have mortgage default insurance).
Some banks and other mortgage lenders will give you the same interest rate for the second mortgage as you got on the first mortgage. The argument is usually that the factors considered when you were getting the first mortgage have not changed. However, not all lenders do this and you may be forced to pay a higher interest on your second and subsequent mortgage.
If you have to pay a higher interest rate, ensure the due date for the first and the second mortgage correspond. This way, you can combine them at the best possible interest rate from the bank once time for renewal comes.
In Canada, mortgages have been on the decline since the early 80s. After a high of 20% in the early 80s, they have ranged between 2% and 5% since then. Over the past 60 years, the average 5-year mortgage rate has been 8.95%, meaning you should ensure you can afford at least 9% interest for a long-term home equity loan.
You should use your home equity loan only in ways that will benefit you such as consolidating your loans to reduce applicable interest. Avoid the common mistake of taking the loan to finance such expenses as vacations that do not add economic value. Talk to a non-profit debt counsellor to determine the debt consolidation method that best works for you