HELOC vs. Mortgage for Existing Homeowners
Choosing between a home equity line of credit and a mortgage can be tricky as both options have upsides and downsides. Keep reading for some tips on navigating the HELOC vs. mortgage debate and reaching a wise conclusion for yourself.
Home Equity Line of Credit vs. Mortgage in Canada: The Basics
First, let’s discuss what each of these options is.
What is a Home Equity Line of Credit?
A home equity line of credit (also commonly referred to as a HELOC) is a revolving loan. It allows you to access equity built up in your home.
Equity, if you’re not familiar, is calculated by subtracting the value of your home from the amount owing on your mortgage. The resulting figure represents money you can unlock with various means of financing, home equity lines of credit being among them.
As with most revolving credit, home equity lines do not typically charge interest until you actually use the money. Further, credit becomes available again after you’ve paid off the balance, provided you are still in the draw period.
How HELOC Draw and Repayment Periods Work
Most home equity lines of credit come with two phases. The draw phase allows you to access available credit at any time. You are also typically required to make interest-only payments, which can make a home equity line of credit very cheap month-to-month during this phase.
Once the draw phase ends (typically 10 years after you receive the loan), you enter the repayment period. During this phase, you’ll need to repay any outstanding balance and interest. Additional funds will not be available to you.
This is where many people find themselves at a disadvantage. After making interest-only payments on their home equity line of credit for 10 years, they suddenly find themselves unable to keep up with the bills during the repayment period. More on this shortly.
What is a Mortgage?
People typically use the term “mortgage” to describe substantial loans given out by financial institutions to help borrowers purchase real estate. With these loans, you’re not tapping into equity but rather receiving a lump sum of cash that you must then repay (plus interest) over the specified term.
While the term “mortgage” can also be used to describe things like home equity lines of credit, those are what you might call second mortgages. This has important legal implications.
A traditional mortgage will always take precedence in the case of foreclosure. Only after that mortgage has been taken care of will second (and subsequent) mortgage providers have any hope of recouping their losses directly from the property.
This is why interest rates tend to be (but aren’t always; it depends on your situation) higher on second mortgages like home equity lines of credit.
HELOC vs. Mortgage: Pros and Cons
Now that you have a solid understanding of what mortgages and HELOCs are, let’s discuss the pros and cons of each. We’ll be exploring these upsides and downsides specifically in the context of buying a second property, which is the only reason the home equity line of credit vs. mortgage debate would be relevant to you.
Pros and Cons of Mortgages
Pro: Interest Rates Can Be Lower
Because the primary mortgage on a property takes precedence during foreclosures, interest rates tend to be much lower than other types of financing. This can make your monthly payments quite reasonable and manageable.
Con: Income Requirements
As mentioned on our comparison page, qualifying for a mortgage can be very difficult when purchasing a second home. Because real estate can be volatile, most banks require proof that you’ll be able to make payments even without rental income from the property.
This is a very high barrier to clear, especially for people who are still paying off a mortgage on their primary residence.
Pro: Benefit from Leverage
If your investment property becomes worth substantially more than your mortgage amount, you can sell it, pay off the loan, and pocket the profits. This is thanks to something known as leverage, which involves using a large amount of borrowed money to control a more valuable asset than you would be able to on your own (even with a HELOC).
Con: You’ll Need Stellar Credit
You’ll find it very difficult to receive a mortgage at a favorable interest rate without stellar credit. This is another reason advertised rates on mortgages at banks tend to be so low; only the best of the best will qualify.
Pros and Cons of Home Equity Lines of Credit
Pro: More Flexibility
As mentioned earlier, a home equity line of credit is typically revolving, which means you can access credit again after you’ve paid it off. Additional flexibility comes in the form of the draw period, which allows you to make interest-only payments on the loan, typically for the first 10 years.
Con: More Diligence Required
With more flexibility comes a greater need for diligence and careful planning with a home equity line of credit. Some people find the promise of interest-only payments for 10 years too alluring and end up overextending themselves financially.
Pro: More Accessible
A home equity line of credit can be more accessible than a mortgage since you’re essentially just borrowing money from your own home. You’ll still need a good credit score, however, but the requirements won’t be as strict.
Further, you may even end up with a lower interest rate than you’d receive with a traditional mortgage. This is because HELOCs are secured loans.
Con: Banks Still Have Stricter Criteria
If you’re looking for a home equity line of credit from a bank or other traditional lender, you’ll still find it somewhat challenging as a result of the stress test requirements.
Other Second Mortgages vs. Home Equity Lines of Credit
While a bank home equity line of credit has its advantages, many people find home equity loans – another type of second mortgage – preferable for a few key reasons.
With a home equity loan, you’re still tapping into equity but not on a revolving basis. Instead, you’ll receive the money and then make part-interest, part-principle payments over the course of the loan term. Learn more about how home equity loans work here.
The bottom line is that this type of financing is much more manageable for many people. It also makes sense financially as people typically seek home equity financing for a specific purchase or expense (i.e. debt consolidation) rather than to have a revolving line of credit.
At Alpine Credits, we make securing a home equity loan very simple. Our primary concern is not your credit score or age but rather the amount of available equity you have in your home. We also strive to approve loans within 24 hours! Learn more and apply for an Alpine Credits home equity loan here.
Tips for Choosing Between Various Types of Home Loans
At this point, you know about three types of home financing: mortgages, home equity lines of credit, and home equity loans. Here are a few tips for choosing between the three.
Consider the Loan’s Purpose
Are you seeking financing for an investment property purchase or some other type of one-time expense? If so, a home equity loan offers a reasonable interest rate and level of accessibility without tempting you with more credit than you actually need.
Evaluate Your Income
Unless you have a very high income, it will be difficult to qualify for a traditional mortgage on an investment property. This is because lenders often want to see that you’re capable of paying the mortgage without any rental income (including from other properties).
If your income is not sufficient enough for this, you’d likely be better off with a home equity loan from a non-traditional lender like Alpine Credits.
Remember that it’s a Borrower’s Market
Interest rates are incredibly low right now, which gives borrowers the upper hand. It’s important that you factor this into your loan-hunting process as it will influence your plan for repaying the debt.
Frequently Asked Questions
A HELOC can be a good idea under the right circumstances. In many situations, however, people find home equity loans preferable as they are a more easily-managed, accessible means of financing.
A HELOC can be better than a mortgage in the sense that it’s more accessible. The value proposition as far as interest rates go depends, however, on your situation. Some people find home equity lines of credit come with higher interest rates than a conventional mortgage while others get them at a comparative steal.
Home equity lenders need to determine your home’s value on the current market to fairly calculate how much equity you’ve built up. This means some type of appraisal process is typically required.
However, a full appraisal may not be required depending on your home’s age.
HELOCs are typically easier to get than mortgages since you’re merely tapping into your own home’s equity (and securing the loan with that equity). However, HELOCs from traditional financial institutions (like banks) can still be difficult to obtain.
Most people find it preferable to secure home equity financing from non-traditional lenders (like Alpine Credits).