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As a homeowner starts to pay down their mortgage throughout the years, they begin building home equity. The more they pay toward their mortgage, the more home equity they gain for future use. Your equity will also rise if and when your property increases in value with the fluctuating housing market. Many homeowners choose to use their equity to finance something important. That particular expense might be anything from a large addition to their house, paying off their existing car loan, or to put their children through school. Whatever that cost might be, they’ll use their equity to pay it down.
Thinking about paying off your mortgage early? Check this out first.
Do I have Home Equity?
If you’ve been paying off your mortgage for several years, then you likely have at least some home equity. As we explained above, you build equity as you pay down your mortgage. If you decide to use your home equity to take out a second mortgage, you’ll need to have your house appraised to determine how much it is worth. But, if you’re simply curious about how much equity you have or want a general idea of how much equity you have before you head to your lender, here’s how to do a quick estimate.
Home value= $376,000
80% of value ($376,000 x 0.8)= $300,800
How much you still owe on mortgage= $232,000
80% of your home’s value – amount you owe on mortgage= $68,800
In this case, you can expect to get a second for $68,800 or less.
Keep in mind that the number you’ll get from the above equation is just an estimate as you’ll only truly know the current value of your house when you get it appraised.
When is a Home Equity Loan a Good Option?
If you need money for…
- Home renovations
- Home improvements or extensions
- A new car
- To cover your children’s school expenses
- For your business
- Debt Consolidation
Then this type of loan is ideal for you. Basically, if you need a large lump sum of cash for whatever the reason, you can get it by obtaining a loan on the equity of your home.
HELOC, Refinance, or Second Mortgage? Find out choice works best for you.
How Do I Gain Access to My Home Equity?
Generally speaking, homeowners can use these traditional methods to access their home equity:
- Home Equity Loans
- Second Mortgage
Home Equity Loans
What Are They and How Do They Work?
A home equity loan is a loan that uses your house as collateral. It works similar to any other type of secured loan. Your lender will let you borrow a specific amount of money, based on the value of your home. You’ll be charged interest and have fixed installment payments.
How Can I Get One?
To get a home equity loan you need to own a house, which needs to be appraised by your lender, have paid off a significant portion of your mortgage, and be financially secure enough to handle taking on more debt.
How Do I Use One?
With a home equity loan, you’ll be able to borrow a maximum of 80% of the property’s appraised value, minus what you have left to pay on your original mortgage. You’ll then need to pay off both mortgages at the same time.
HELOC (Home Equity Line of Credit)
What Are They and How Do They Work?
There are a few notable differences between a home equity loan and a home equity line of credit. The first difference is that a HELOC is just that, a line of revolving credit, as opposed to a loan, which is one large sum of money. Because of this, you can use that line of credit at your leisure and regain access to the full limit as you pay off the balance.
How Can I Get One?
You’ll be able to open a line of credit through your bank, or most traditional financial institutions, as well as private mortgage lenders. However, banks will typically require a high credit score in order for you to qualify. Potential borrowers must first have their property appraised to make sure they have enough home equity to qualify for a HELOC. These lines of credit are only granted to borrowers who have at least 20% home equity in their property.
How Do I Use One?
You are able to open a HELOC for up to 65% of your property’s appraisal value. However, if your lender combines your HELOC with the remainder of your mortgage, you’ll be able to increase the borrowing limit to 80% of the home’s appraised value. One your line of credit is secured, you can borrow from it as you wish, as long as you keep up with the minimum monthly payments.
Check out this infographic for tips on how to purchase a house in Canada.
Refinancing Your Mortgage
What is It and How Does It Work?
Refinancing your mortgage implies creating a new mortgage loan to replace the old one. In exchange, you will have access to a certain amount of the equity you have accumulated. You’ll need to meet with your lender to determine just how large of a loan they can provide you with. It’s important to understand, however, that you will likely have large payments to make and your equity will decrease.
Refinancing your mortgage requires an appraisal. Check out our appraisal checklist.
How Can I Do This?
Once again, you’ll need to have your property appraised. You’ll then need to break your original mortgage contract and renegotiate for a new one through your current lender or a new lender. Just be aware that if you decide to refinance your mortgage in order to gain access to your equity, you could be charged a prepayment penalty fee for breaking your mortgage contract. However, if your mortgage is ready for renewal or your lender’s penalty fees are not too steep, refinancing might be the most reasonable option for you.
A second mortgage is a loan taken out against your property that is already in the midst of being mortgaged. In this case, your house will act as collateral, which will allow you to gain access to the second loan. Be very careful when taking out a second mortgage, as you’ll now have two separate mortgage payments to make. Since your home is acting as collateral, if you start missing mortgage payments and your lender determines that you won’t pay them back, they have to right to foreclose on the house and possibly sell it to recuperate part of their loss.
Trying to refinance a second mortgage? Here’s how.
Some of the Advantages of Using Your Home Equity
- You can use your equity to strengthen your home’s value – Since your home is an asset, you can use your equity to finance any renovations you might want to do, thus increasing your home’s market value, if and when you decide to sell it.
- Interest may be deductible on your tax return – If you decide to use the extra money from your second mortgage loan for investments that will produce an income, it’s possible to use the interest for a tax deduction.
- You can use your equity for anything you want – While some homeowners choose to use their home equity for renovations or to finance other properties, others will use it to pay for their children’s or their own education, or even go on vacation. You can also use your equity to consolidate any other higher interest debts you might have on your plate.
Some of the Disadvantages of Using Your Home Equity
- You need to pay for various fees before you can borrow – There are a number of costs that you have to pay for before you are allowed access to it, such as fees for the appraisal, the application, and legal documents.
- Variable rates = variable interest costs – You might choose to borrow at a variable rate because initially, the rate might be cheaper than that of the fixed-rate option. However, be aware that if you choose a variable rate your interest rate can change.
- Using your equity for investment purposes comes with its own risks – If you decide to use your home equity to make unsheltered investments, not only is it likely that you will have to pay taxes on them, but like any unsheltered investment, there’s the possibility that you could lose your money because of how the stock market fluctuates.
- Failure to make your payments can result in your home being taken – Defaulting on your payments can lead to your home being foreclosed. So, before taking out a second mortgage, you need to be absolutely certain you’ll be able to make regular payments.
Mortgage Rules in Canada
As of October 2016, there have been several changes put in place for Canadian housing rules. The Liberal Government is trying to assure that new homebuyers are only purchasing houses that they can afford. Mortgage rates have in fact been on a steady decline in recent years, making houses in many provinces more affordable. However, the Canadian Government is concerned about what will happen should those interest rates rise in the years to come, which is more than likely. So some changes have been implemented to hopefully lessen the risk for both borrowers and lenders. Click here to read up on some of those changes.
How Will You Use Your Home Equity in 2021?
In the end, the way you decide to access and use your home equity is up to you. Whatever path you choose should be based on your financial situation, so don’t make that choice until you’ve gotten all the advice you can and weighed all your options equally. If you’re having trouble figuring out which solution will suit your needs best, Loans Canada can help match you with the right home equity loan product and licensed specialist.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
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