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Second Mortgages

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Second Mortgages

Equity is an asset that your home accumulates as you pay down your mortgage. You can also increase your equity by making renovations or otherwise improving how valuable your property is. Your equity will even rise by itself if your neighbourhood becomes more desirable.

To calculate how much home equity you have, simply tally up the estimated real estate value of your property and subtract the balance remaining on your existing mortgage. 

Once you have at least 20% equity, you’ll be able to access a variety of credit products that are secured against it. 

Why Borrow Using Your Home Equity?

Although the idea of home equity may be confusing at first, it can also be a huge commodity, considering all the ways you can use it to your advantage. In fact, most Canadian home buyers dip into their home equity at one point in order to:

  • Access large amounts of credit and affordable interest rates
  • Consolidate various bills, debts, etc. 
  • Invest in home repairs or improvements
  • Finance a new or used vehicle
  • Start a small business
  • Cover the cost of secondary education
  • Make large purchases

As mentioned, there are several credit products that you can apply for once you have sufficient equity. Since these options can affect your finances and are secured using your home as collateral, always speak to a financial advisor before you decide which is right for you. 

While getting approved isn’t always easy, it’s often worth the effort, as you may be able to borrow far more money than you would with the average installment loan, credit card, or personal line of credit. 

Did you know that you can also tap into your home equity to pay off a consumer proposal? Learn more here

Second Mortgage 

The most common way to access your home equity is through a second mortgage. The term “second mortgage” is used because the loan is second in priority in case of default. This means that if a borrower defaults, the first mortgage will be paid off before the second if the property is sold to pay off the debt. 

When choosing to access your home equity via a second mortgage, you’ll have two products to choose from; a home equity loan or a home equity line of credit (HELOC).

Home Equity Loan

A home equity loan is a one time sum of money that will be directly deposited into your bank account. The loan is of course secured by your home equity and will need to be repaid through installments, typically anywhere from five to fifteen years. Interest will be charged on the full loan amount. 

A home equity loan might be a preferable mortgage product because:

  • Equally divided payments are easier to calculate and budget for
  • Many lenders charge fixed interest rates that won’t change during your loan term and are sometimes lower than variable rates
  • It’s a good solution for immediate home repairs and other one-time expenses

Before you consider a home equity loan, don’t forget about these drawbacks:

  • The interest rate will be higher than your first mortgage
  • You will have to borrow one large sum and pay interest on the full amount
  • Your house acts as collateral, which could put it at risk

Home Equity Line of Credit (HELOC) 

A HELOC functions more like a credit card, in that you’re able to withdraw from a revolving credit limit, make minimum monthly payments, or pay off your balance to regain access to your full limit. Typically, you will be able to borrow up to 85% of the value of your house. HELOC interest rates are usually variable and thus fluctuate based on an index. This will affect your monthly payments and make them less predictable that the payments associated with a home equity loan.

You may prefer a HELOC because:

  • You only have to borrow the amount you actually need, not a lump sum
  • Interest will only be applied to the amount you use
  • It’s possible to make multiple, partial, or minimum monthly payments
  • You can

If you’re opening a HELOC, watch out for these problems:

  • You might pay more interest overall if you don’t consistently make full payments
  • Variable interest rates will apply, which can be higher than fixed rates (if Canada’s prime rate rises during your term)
  • Many lenders charge a yearly fee to keep the HELOC open
  • Again, you’re using your house as collateral and could be putting it at risk.

For a more detailed look at the difference between a home equity loan and a HELCO, click here

Advantages and Disadvantages of Borrowing Against Your Home

Although using your home equity can help in many scenarios, it’s important to understand the potential benefits and drawbacks, as they can impact your lifestyle. 

Advantages

  • With enough equity, you can gain access to a significant amount of money over a long period of time, without having to sell your home
  • These funds can help you cover a variety of expenses
  • Responsible payments are very good for your credit  
  • Applying with a lot of equity and healthy finances can earn you better interest rates than with unsecured credit products

Disadvantages

  • Two repayment plans will be tough on your savings and, if handled irresponsibly, can lead to debt, damaged credit, and even the foreclosure of your home 
  • You will likely pay more interest over time, especially if it’s your second mortgage 
  • There are many other costs associated with the lending process, including loan origination, appraisal, accounting, and legal fees  
  • It can be hard to qualify for favourable home equity products if you have bad credit, a low household income, or if you’re a new homeowner
  • The more mortgage debt you take on, the less equity your property will retain   

Home Equity Product FAQs

If you’re still not sure which home equity product is right for you, write down a few questions to ask your lender, financial advisor, or other homeowners you know, such as:

Do I Need Good Credit to Borrow From My Home Equity?

The main elements that your lender will examine when you apply are your total home equity and overall ability to make payments. So, in certain cases, your credit will not be a major factor, like with a reverse mortgage.

That said, depending on which home equity product you choose, many lenders will use your credit to determine your interest rate. More often than not, better credit means you have less chance of defaulting, so you may qualify for a lower rate. 

I Bought My House Last Year, Can I Get a Home Equity Loan?

Remember, the home isn’t truly yours until you’ve paid off your primary mortgage. If you have totally purchased the property, congratulations; you have full equity and much better approval odds as a result. However, if you’ve just started mortgaging the home and didn’t make a large down payment, you may not have enough equity to qualify.

What Happens to My Home Equity Product When I Sell My Property? 

Typically there are two scenarios that can play out. Your lender requires that you pay back your home equity product in full before the sale of the house or they allow you to pay off your debt using the proceeds from the sale of your house.

When applying for a home equity product, it’s important that you understand how the potential sale of your house will affect your debt before you sign on the dotted line. 

Contact Loans Canada For All Things Home Equity

Borrowing using your home equity may seem like a complicated process but it is a great option for those consumers looking to access larger amounts or pay down high-interest debt. If you’re looking to dip into your home equity, don’t hesitate to contact Loans Canada, we can help match you with the right home equity product. 

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