Buying a home may seem like a one-time purchase, but it’s actually a long-term investment. As you continue to live in the home, the property should begin to appreciate and as a result, you will begin to build equity. Your home’s equity is the value of your home minus the outstanding balance of your mortgage. This equity can come in handy later on in life when you need to pay for renovations, consolidate debt, or maybe just make ends meet.
According to experts, the primary ways to take advantage of your home equity are through one of many “second mortgage” options, or by breaking your mortgage altogether and starting a new one — also known as a refinance.
Each of these options has its own advantages and drawbacks. This article will walk you through all the different ways you can access your home equity and when you may want to take advantage of each one.
Second mortgage options
A second mortgage refers to any mortgage taken out after a first mortgage. This includes homeowners who take out a HELOC to use the equity in their home, or homeowners who choose to purchase an additional property with an additional mortgage.
A second mortgage is defined as any mortgage that takes second position to your first mortgage, meaning that if you should default on your payments, the loan on your first mortgage will need to be paid off before the second. While some second mortgages offer this option, not every second mortgage gives homeowners the option to utilize the equity in their homes.
The benefit of taking on a second mortgage is that you won’t have to pay the fees associated with breaking your mortgage. However, you’ll now be accountable for two separate loans.
Here are the second mortgage options that let homeowners access their home equity:
- Home equity line of credit (HELOC)
A HELOC refers to a line of credit secured against the equity of the home. Homeowners only need to repay the equity they withdraw, which is very similar to a typical line of credit. This option makes sense for homeowners who are looking to quickly access money for the lowest monthly payment. It might also make the most sense for homeowners who don’t know exactly how much money they’ll need.
If you’re looking for the lowest payment, a HELOC makes sense since in most cases you can make interest-only payments
Those who choose this option will only have to make interest payments on what they borrow, as opposed to fixed payments, explains mortgage broker Sean Cooper. Interest rates for HELOCs are usually higher than mortgage rates, though. If you’re considering a HELOC, it’s important to weigh the risks as well as the benefits. Borrowers should keep in mind that banks can raise the rate of a HELOC at any time or ask you to repay the entire amount whenever they like — even if you haven’t used the whole amount.
Furthermore, as of 2008, HELOC borrowers who wish to apply for a new mortgage need to prove that they can afford to pay back the entire value of the line of credit, not just what they’ve borrowed.
- Home equity loan
A home equity loan has some similarities to a HELOC, though it bears more resemblance to a personal loan secured against the equity of your home. A homeowner who takes out a home equity loan borrows a lump sum against their home equity and must make regular payments, which include a fixed interest rate.
Homeowners who are sure of the amount they’ll need may want to consider this option since they’ll be able to calculate the cost of borrowing as soon as they take out the loan.
- Reverse mortgage
A reverse mortgage is an option specifically designed for elderly Canadians who have paid off at least 50% of their mortgage. A reverse mortgage allows senior homeowners to borrow up to 55% of the value of their homes. No income verification is required, and you won’t have to make regular payments.
Seniors might be interested in this option because they won’t be obligated to make a monthly payment until they sell their home or pass away, and they’ll also maintain ownership of their home. Homeowners interested in reverse mortgages should keep in mind that this option can reduce the amount of equity they have to leave their family should they pass away.
There are only two banks in Canada that offer reverse mortgages: HomeEquity Bank and Equitable Bank.
Breaking your mortgage
Taking out a second mortgage isn’t the only option for homeowners looking to take advantage of their equity. Replacing your current mortgage with a new one, also known as breaking or “refinancing” your mortgage, is a way to access your home’s equity. Just like a second mortgage, this option comes with benefits and drawbacks.
- Refinancing your mortgage
Refinancing your mortgage refers to breaking your current mortgage and beginning a new one at a different interest rate. You can access up to 80% of your home’s equity by increasing the value of your mortgage through a refinance.
I’d think long and hard before withdrawing equity out of my home for renovations that aren’t going to add value
Refinancing usually comes with lower interest rates than taking out one of the second mortgage options above. However, this isn’t the right option for homeowners who are planning to leave their home in the near future.
Another benefit of refinancing is that some lenders might be willing to cover the costs, such as appraisal and legal fees, which can stretch into the thousands of dollars.
“It’s helpful to speak with an independent mortgage broker to find out what your options are,” says Cooper.
Whatever you do, don’t ‘treat your home like an ATM’
While your property can be a useful tool when looking for additional funds, it’s important to think carefully about any decision to access your home equity.
“I’d think long and hard before withdrawing equity out of my home for renovations that aren’t going to add value, like a swimming pool,” says Cooper.
The main risk for homeowners is that they take too much equity from their homes and wind up with very little to pass on to their beneficiaries.
“If they fail to repay the funds, they are putting their home at risk,” says Cooper. “They may no longer have a roof over their head in a worst-case scenario.”
So while your home can be a great way to access funding and consolidate debt, make sure you don’t overdo it. Speak with your lender or a financial advisor about whether any of these options are right for you.