You've worked hard to pay your mortgage down. Maybe you've made extra lump-sum payments or accelerated your payment schedule. Now, you're sitting on a nice pile of equity asking the question, "what's the best way to use it?" There are two primary ways to access the equity in your home: refinancing with a standard mortgage or setting up a HELOC.
Refinance with a Standard Mortgage
Mortgages are not just for buying property. They can also be used to take advantage of the equity in your home. With appraised values skyrocketing in most parts of Canada right now, this can be a good solution to access money for a number of reasons such as paying off higher interest debt, a down payment for another property, or investment opportunities.
Refinancing with a standard mortgage generally means paying out your existing mortgage, and replacing it with a new mortgage which can be up to 80% of today’s appraised value. You will continue to make principal and interest payments at the new amount with the typical options of the mortgage you most likely have today.
Home Equity Line of Credit
A home equity line of credit (HELOC) also allows you to borrow up to 80% of the equity in your home. The main difference is that instead of a lump sum, the HELOC can have up to 65% of your equity as a revolving credit product, like a credit card, and the additional 15% minimum as a fixed portion principal and interest payment like the standard mortgage above.
Some HELOCs can be combined with this mortgage portion, called a readvanceable mortgage. As you pay down your mortgage, the amount of credit available in your HELOC will go up, since the equity in your home increases.
Most HELOCs tend to have variable interest rates for the line of credit portion that don’t require a fixed repayment schedule. At a minimum, you’re required to pay interest on the funds used.
The Pros and Cons of a Refinanced Mortgage
This option is great if you want to do something specific with the lump sum, such as pay down debts or complete renovations. But all the money left on the mortgage is advanced at once after your current 1st mortgage is paid off. There’s also the added benefit of a fixed interest rate over say a 5 year term which might fit your budget better.
A con is that there will most likely be limits on prepayment privileges, similar to your existing first mortgage, and additional legal fees.
Another benefit is that quite often you can refinance your property with your existing lender, and by keeping your mortgage at the same company quite likely lessen the penalty for early payoff, and sometimes avoid it all together.
But ask yourself, are you using the lump sum to free up credit and then buy more with the available credit?
That gets risky especially when your home is being used as collateral. If you’re using the loan to pay down credit cards, you don’t want to start racking up your cards again
The Pros and Cons of a HELOC
A HELOC is attractive because of its flexibility. There is no fixed repayment schedule and you’re only required to pay interest on the funds used. This can be a great option if you have fluctuating expenses, like running a business or are sending your child to post-secondary school.
Because the HELOC is revolving, you have access to these funds at any time, as long as you have credit available. And, you can pay down the amount owing without penalty.
If you have a readvanceable HELOC option, you have ongoing access to the increased equity in your home. As your mortgage is paid down, the available credit on your HELOC will increase (up to 80% of your home’s value).
But, with flexibility comes risk. Because there is no principal payment required on the HELOC portion, it’s easy to start racking up credit faster than it’s being paid down. And as the amount owing on the HELOC increases, so does the minimum interest payment. You could quickly find you’re paying a couple hundred dollars a month just on interest if you’re not careful with your spending.
What Happens To A Refinanced Mortgage or HELOC When You Sell?
Because both of these products are tied to your home, a home equity loan mortgage or HELOC will need to be paid off in full when you sell your home. Makes sense, right? You no longer own the home, so you don’t have collateral to back your loan/line of credit.
Most people will have the proceeds of the sale of their home payoff their HELOC/loan at closing. However, if your home is worth less than your mortgage, this option isn’t going to work. You need to pay off the HELOC/loan fully before you sell or wait to sell your home.
For both of these collateral options, you’ll need to decide how long you plan to stay in your home. If you think you might be moving within or at the end of your mortgage term, you should consider what’s the best product to minimize costly penalties.
Even If You Already Have a House, You Still Need to Qualify
That whole thing about nothing comes for free? Yeah, that still applies here.
Even if you have already qualified for your mortgage, you’ll still need to go through a similar qualification process for your home equity loan or HELOC. The lender needs to verify there’s actually equity in your home and that you’ll be able to repay the amount received.
The process is similar for an unsecured line of credit. You will have to qualify to determine your credit amount, interest rate, and other privileges. Depending on your relationship with your bank, the qualification process may not be as strict.
Which Option To Access Your Equity is Right For You?
You likely have an idea of what option would be best for you: do you need to cover a one-time cost or ongoing costs? Do you like fixed payments versus flexible? Are you planning to stay in your home for a long time? Can you follow a budget so payments don’t get out of hand?
Whatever the case, you don’t know what options you have until you ask. Text me if you're looking to access the equity in your home!