When you buy a house and take out a mortgage, you make regular payments on that loan until it is totally paid off. A portion of each payment goes toward interest, and the rest goes toward the principal amount borrowed. As the principal on the loan gets paid down and the value of your home increases, your home equity grows. In other words, your equity is what you own outright, or the difference between the value of your home and the amount you still owe on your mortgage.
There are several ways to access your equity and put those funds to work for you elsewhere. The most common options are a Home Equity Line of Credit (HELOC), a second mortgage, a reverse mortgage, and refinancing your home.
A HELOC is a revolving loan that requires regular repayments once the money has been accessed.
A second mortgage allows you to borrow up to 80 per cent of your home’s value – however, it will be at a higher interest rate.
A reverse mortgage is more commonly used by older homeowners. In this situation, the homeowner can borrow up to 55 per cent per cent of the home’s value. Repayment is due in one lump sum at the end of the loan period, typically when the homeowner sells the home.
Finally, refinancing your mortgage means that you borrow more than your current mortgage and up to 80 per cent of your home’s total value. This means that you can borrow more money than the amount of your original mortgage.
These four types of equity loans provide many options for Canadians wishing to use home equity to improve their lives. Read on to find out how!
Top Ways Canadians Are Using Home Equity
Renovations
Home equity loans are often used to finance home improvements. Essentially, you’re using your home’s current value to increase its future value. The most significant benefit of using this type of loan for this purpose is that it usually carries a lower interest rate than credit cards or lines of credit. When using home equity for renovations, it is essential to consider the project’s cost, timeline and scope.
Should the renovation be minor, not urgent, and something you can save up for in a few months, an equity loan probably isn’t ideal, since you will have to pay interest on the money you borrow. However, if the renovation is a larger, more expensive project, a home equity loan is ideal because of the low-interest rate and the repayment flexibility.
Tapping into your equity to improve your home can be a good investment because you use the asset to enhance itself, increasing its value while not being charged excessive interest on the loan.
Purchasing a Second Property
Some homeowners use their home equity to pay for a second property that may be used for rental income. This gives them more flexibility than taking a standard mortgage on the new property because, in some instances, you only have to pay back the interest and then can make payments as you desire (or a lump-sum payment) on loan.
What Not to Use It For
While a home equity loan is helpful because it gives you access to a large amount of money for a lower interest rate than a line of credit or a credit card, these funds shouldn’t be used for non-essentials. Avoid using your home equity to cover daily expenses, the cost of a vacation, or to pay down credit card debt.
This type of loan carries interest, so if you’re using that to pay for a vacation or daily expenses, you’ll be paying more than the listed price. For these items, a better option would be to save up. Finally, using it to pay off credit card debt is a double-edged sword. Yes, you will consolidate your debt and end up paying less interest overall, but it won’t solve the problem as to why you’re carrying credit card debt in the first place, and increases the risk of this issue recurring in the future.
Home equity loans can be a great way to invest in a renovation, purchase a second property, or fund significant one-time expenses that you otherwise would not be able to afford. The lower interest rates and flexibility in the home equity loans available can provide tremendous benefits to homeowners. However, it is essential to consult with a financial professional to discuss all your options.
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