The competitive mortgage market in Canada offers homeowners a variety of home equity loans with competitive rates. Homeowners must have a specific amount of equity built up to qualify for a home equity loan. Home equity loans come with a higher interest rate than other mortgage refinancing options, so it’s important to understand how to build up your home equity.
Understanding home equity loans may help you determine if now is a good time to take out a loan. This guide will help you understand how home equity loans work and how to maximize their benefits.
What Is Home Equity?
Home equity is one of the greatest assets you have as a homeowner. Home equity is the value of ownership in a home. The equity of your home is measured by how much it has appreciated over time. The higher the appreciation, the greater your equity.
You can calculate the equity in your home by subtracting how much you owe on your mortgage and any other loans from the market value of the home. Home equity is a valuable asset for homeowners since it can be used to borrow home equity loans or lines of credit.
How does Home Equity Work?
As a homeowner pays down their mortgage over time, they begin gradually gaining equity in their home. The more money that is put toward the loan, the more equity you will have for future use.
Equity also usually increases with rising housing prices because your property could be worth more later. Homeowners often use their equity to finance something they might not otherwise be able to afford. This can include large home projects, paying off car loans, or putting children through school. However much that cost might be, they could use their equity to pay it off.
For most homeowners, borrowing against home equity is an effective way of securing loans at low repayment rates. Determining the value of your home can be a simple calculation by taking the current amount owing for the mortgage and then subtracting this from the total estimated worth.
Calculating Home Equity Example:
- Amount still owing on the mortgage
- Home value= $398,000
- 80% of value ($398,000 x 0.8)= $318,400
- Balance on mortgage= $254,000
- 80% of your home’s value minus the remaining balance on mortgage=Home Equity. (318,400-254,00=$64,400)
In this case, the available equity built out for an equity loan is 64,400. This equation is only an estimate of your accumulated equity. To calculate your exact equity over time, you need to get a professional appraisal.
How Do I Calculate How Much Equity I Have?
If you’ve been paying off your mortgage for several years, then you likely have some equity. It typically takes a few years before your home equity starts to build because most of those payments go towards the interest instead of the principal balance. Conducting an appraisal on your home can give you better insight into the equity that has accumulated over time. This scenario will help you estimate what your potential equity could be after such an appraisal.
What Is A Home Equity Loan?
Home equity loans are secured by the value of your home and offer competitive interest rates. Home equity loans allow you to borrow money using the equity in your home as collateral.
Since your home value is used as collateral for the home equity loan you can borrow much higher opposed to credit cards and personal lines of credit. This can be for any purpose, whether it’s a small home remodel or emergency medical expenses.
How Do Home Equity Loans Work?
Home equity loans give you up to 80% access to funds against the home’s value with higher limits than unsecured credit cards or personal lines of credit. They are accessible with low-interest rates because the lender will use your house as collateral should you be unable to pay back the debt.
When you take out a home equity loan, remember that you will be charged closing costs. Closing costs typically run from 2-5% of the loan amount. The interest rate on your equity loan depends on your credit score. The higher your credit score the better interest rates you may get on a home equity loan.
There are several different types of home equity loans, and the amount you can borrow will depend on which type you choose.
Types Of Home Equity Loans
Second mortgages
Second mortgages are a type of home equity loan and are an extension of your primary mortgage. A second mortgage allows you to borrow a portion of your home’s equity as cash.
Just as with first-time mortgages, both loans cannot exceed 80% of your home’s total value. A second mortgage has a higher rate than a regular mortgage to cover the added risk of default.
Home Equity Line of Credit (HELOC)
A HELOC is a credit line that you can withdraw money from for the duration of your mortgage term based on how much equity you have in your home. A home equity line of credit can be bundled with your primary mortgage to increase your borrowing power. Your lender will set up an account that you can take from over the course of your mortgage term.
The HELOC works as a revolving credit line which, when you withdraw funds from it, requires monthly payments to pay back money owed on interest. The interest rates on HELOCs are much lower than credit cards because it is secured by your home. The percentage of the money available to be withdrawn will depend on up to 65% – 80% of your home’s total value.
Accessing Home Equity By Refinancing
Another way to access your home equity is to refinance your mortgage. Refinance replaces your existing mortgage with a new loan. With refinancing your mortgage you can take out a portion of their home equity in a lump sum at the same time. You can borrow the maximum amount of 80% of the total value of your home when you refinance.
Since the new home loan balance is higher the interest rates will be higher on the new home loan. When you refinance, you can expect the same closing costs as when you first purchased your mortgage.
Reverse mortgages
A reverse mortgage provides Canadians 55+ with a product that can help relieve their financial worries during retirement. One of the features of this product is that no regular payments are required.
A reverse mortgage is a type of home equity loan in which people aged 55 and over can borrow up to 55% of their total home value as installments or as a lump sum. There are no repayments required on the loan until the borrower sells or moves out of his/her house, or dies. The proceeds of the sale are typically used to repay the loan.
Reverse mortgages also accrue interest over time, and at a rate that tends to be higher than both regular mortgages and HELOCs. Reverse mortgages can be repaid early with a fee, but should not be done before the end of the term.
Home Equity Line Of Credit (HELOC)
A home equity line of credit, or HELOC, uses your home as collateral. It is a revolving line of credit with an interest rate much lower than that for conventional lending. Interest rates are only charged on the amount you withdraw.
You can borrow up to 80% of your home’s value as long as it does not exceed $650,000 and your lender combines your home equity credit limit with the remaining balance of your mortgage.
Loans And Lines Of Credit Secured By Your Home
If you have consistently made mortgage payments in full, your lender may allow you to borrow funds from this account for a short period of time.
Benefits Of Home Equity Loans
The benefits of a quick and easy application process make this a good option for homeowners looking to get cash fast. When your loan is approved, you can typically expect to receive funding in as little as 48 hours. A home equity loan offers a competitive interest rate that is comparable to that of a first mortgage. One of the many benefits of a home equity loan is that it comes with an appraisal process at your home to make sure you are not overpaying for a new loan or refinancing if homes in your area have gone down in value.
There are normally fewer fees associated with a home equity loan than those associated with unsecured borrowing sources such as credit cards, and these loans can be used for any purpose, such as financing a luxurious remodel or paying for tuition. If you consolidate your high-cost credit card debt in a home equity loan, it can save you thousands of dollars. Home equity loans can give you access to funds through credit cards and checks, with rates lower than unsecured loans or credit cards. HELOCs are an excellent emergency source of cash because they have the lowest interest rates of any loan options.
Drawbacks Of Home Equity Loans
Home equity loans have drawbacks that borrowers need to be aware of when considering their options. For instance, you may need a strong income or good credit to be eligible for a home equity loan such as the HELOCs. If not, chances are that your interest rate will be on the higher end.
Your interest rate can change and you risk paying more in monthly mortgage payments if the prime rate increases. Unfortunately, accounts may be frozen in the event of default on your higher-interest mortgage and your home may be seized. The interest rates are not always in line with low-rate (s) HELOCs.
You should consider some of the disadvantages before you take out a home equity loan. These loans require strong income and good credit, or else second mortgages can carry 10% interest rates or higher. The interest on reverse mortgages compounds until paid off because there are no payments required until the sale of the home. The market for a reverse mortgage is limited because there are only two providers: HomeEquityBank and Equitable Bank.
What Qualifications Are Needed To Get A Home Equity Loan?
When applying for a home equity loan, you will need to meet the requirements set out by the lender you have selected. You will need a credit score that is high enough and proof that your income is stable enough to cover repayment. To qualify for a home equity loan, you will need to have an income-debt ratio below 40%. For most lenders, you must have a minimum of 20% equity accumulated to qualify for a home equity loan. You’ll need to provide the necessary documentation, such as proof of ownership and a mortgage statement, and a home appraisal to determine if you’re eligible for this loan.
The Bottom Line
Selecting a lender can prove more complicated however as there are many different ones to choose from which offer different interest rates and conditions. Before borrowing against your home equity, it is important to carefully consider what type of loan you will need. Interest rates on these types of loans are higher and the repayment applies to the item that was borrowed against (property or land ownership).
Home Equity Loans are an affordable option with low-interest rates and flexible repayment terms. If you don’t repay your home equity loan, the lender can take over and sell your house to settle the debt. The more you borrow against your house or condo, the higher your risk is.
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