Refinance, HELOC or second mortgage: three ways to borrow against your home

In Canada, you can borrow against your home's equity three ways: refinance into a bigger mortgage, add a home equity line of credit (HELOC), or take a second mortgage. With a bank or other federally regulated lender, a refinance can take total borrowing to 80% of the home's value, and a HELOC can be up to 65% of that value within the same 80% total. A second mortgage sits behind your first and leaves the first alone, but usually comes from an alternative or private lender and costs more.

Start with equity and the 80% limit

Equity is the home's value minus what you owe on it. Lenders measure borrowing as loan-to-value (LTV), the total of your mortgages divided by the home's value, usually as confirmed by the lender's appraisal.

For banks and other federally regulated lenders, OSFI, the federal regulator, caps an uninsured mortgage at 80% LTV. The 80% LTV cap is the ceiling for a refinance, and the same cap applies to a mortgage and a HELOC combined.

Within that combined cap, the revolving HELOC portion can be at most 65% of the home's value; anything above 65% must be paid down on a schedule. The details are in OSFI's guidance and on the Financial Consumer Agency of Canada's home equity page.

You also have to qualify for the new borrowing. A refinance or a HELOC is tested under the stress test: you must show you could afford payments at the greater of your contract rate plus 2% or 5.25%. Our stress test explainer walks through the stress test.

Option 1: Refinance

A refinance replaces your current mortgage with a new, larger one, and you receive the difference in cash at closing. You end up with one mortgage and one payment, usually at a first-mortgage rate, which generally costs less than other ways of borrowing against a home.

The main cost of a refinance comes from breaking the old mortgage. If you refinance before your term ends, your lender charges a prepayment penalty. The penalty is usually the higher of three months' interest or the interest rate differential (IRD), an amount based on the gap between your rate and the lender's current rate for the time left on your term.

On a variable-rate mortgage the penalty is commonly three months' interest. Your mortgage contract sets the exact method. You also pay a lawyer to register the new mortgage, and often for an appraisal.

A refinance has a trade-off: you lower your borrowing cost on the new money, but you restart the mortgage at today's rates on the whole balance. If you stretch the amortization, you pay interest for longer. Refinancing at the end of your term avoids the penalty, so timing matters.

Option 2: HELOC

A HELOC is a revolving line of credit secured by your home. You draw on a HELOC when you need to, pay interest only on what you use, and can borrow again as you repay. Many people hold a HELOC alongside their mortgage, sometimes in a combined product that links the two.

A HELOC suits needs that come in stages or are uncertain: a renovation paid over months, a cushion for irregular income, or a known expense with no fixed date.

A HELOC's flexibility has a cost. HELOC rates are usually variable, so your interest moves with the market. Because the minimum payment can be interest only, the HELOC balance does not shrink unless you pay it down yourself.

Setting up a HELOC usually involves legal and appraisal costs, though adding a HELOC alongside your existing mortgage generally does not trigger a prepayment penalty.

Option 3: Second mortgage

A second mortgage is a separate loan registered behind your first mortgage. Your existing mortgage, rate and term stay exactly as they are. Leaving the first mortgage alone can make sense when breaking the first mortgage would trigger a large penalty, or when you need money for a short time.

Second mortgages often come from alternative lenders, which accept less conventional applications at a higher cost, or from private lenders. Expect a higher rate than your first mortgage, lender and broker fees, legal and appraisal costs, and a shorter term. Any fee must be disclosed to you in writing before you commit.

A second mortgage makes most sense as a short bridge with a clear plan to repay it or fold it into a refinance later.

Worked example: a $900,000 home with $500,000 owing

Say the lender's appraisal confirms a value of $900,000 and you owe $500,000. Your LTV today is about 56%.

• Refinance: 80% of $900,000 is $720,000. Replacing the $500,000 mortgage with a new one of up to $720,000 could free up to $220,000, before the penalty and closing costs, and subject to lender approval and the stress test.
• HELOC: the combined limit is the same $720,000, so with the $500,000 mortgage in place, a HELOC of up to $220,000 fits. The 65% revolving cap ($585,000) does not bite here, because the 80% total is reached first.
• Second mortgage: your $500,000 first mortgage stays untouched and the second lender sets its own limit and price on top.

Now look at the penalty for breaking the first mortgage. On a $500,000 fixed-rate balance at an illustrative 5% rate, not a quote, three months' interest is about $6,250. The IRD could be higher, so ask your lender for the actual figure before you decide.

If the penalty is large and you need $50,000 for a year, a HELOC or a second mortgage may cost less overall than breaking the mortgage. If you need $200,000 for the long term, a refinance often wins despite the penalty.

When a refinance, a HELOC or a second mortgage fits

• Refinance when you need a lump sum, want one payment, and either your term is ending or the penalty is modest.
• HELOC when you need flexible access over time and are disciplined about paying the HELOC down.
• Second mortgage when the first mortgage should stay put, your situation does not fit a bank today, and you have a clear plan to repay the second mortgage within a short time.

If you are borrowing to pay off higher-interest debt, run the numbers on the total interest over the life of the loan, not just the monthly payment. A lower payment spread over 25 years can cost more than it saves.

What to do next

Gather your latest mortgage statement and ask your lender for a penalty figure. Then use our call-me-back form and we will compare the three options for your home. We never ask for documents, your SIN or account numbers by e-mail. You can also read more about refinancing with a broker. All mortgages are subject to lender approval.