All You Need To Know About Getting A Home Equity Loan
Homeownership is a significant milestone, but it also comes with financial responsibilities. If you are a homeowner in need of a large sum of money for home renovations, education expenses, or any other big-ticket purchase, you have an option to use your home’s equity to secure a low-interest loan, known as a home equity loan. In this blog, we will discuss everything you need to know about home equity loans, including how to get one, the different types of home equity loans available, and the best ways to use them.
What is home equity?
Home equity is the portion of your home’s value that isn’t encumbered by a mortgage. For example, if you purchased a home for $450,000, and you had a 20% down payment of $90,000, then you’d need a mortgage for the remaining value of the home, or $360,000. Your equity in your home is the difference between the value of the home and the mortgage, or in this case, $90,000.
Over time, the value of your home may appreciate, or you may pay down your mortgage, thus increasing your home equity. As you uncover more equity in your home, some of it can be used as collateral for a home equity loan.
What is a home equity loan?
A home equity loan is a loan that allows you to borrow money by using your home’s equity as collateral. Since you are using an asset to guarantee the loan, the amount you can borrow can be quite large, and the interest rates are extremely low – much lower than credit cards or personal lines of credit.
There are several types of home equity loans, but most of them fall into one of the following two categories:
1. Lump-sum payment: With this style of loan, you receive a large lump sum payment all at once and pay back the amount over time at a set interest rate.
2. HELOC: A HELOC is similar to an unsecured line of credit in that you can borrow all or some of the maximum limit, pay back the debt, and then borrow again at a later date.
Pros and cons of a home equity loan
A home equity loan can be an excellent source of cash, but it also has some drawbacks.
Pros:
- You can use the money for any reason, from home renovations to sending a child to college
- You can choose between receiving a lump sum now, a revolving credit line, or even a reverse mortgage which requires no payments until you sell your home
- With a HELOC you can access your funds through credit cards and cheques
- Interest rates are much lower than unsecured loans and credit cards, making a HELOC an excellent emergency source of cash
Cons:
- HELOC interest rates are variable, which means they fluctuate with Canada’s prime interest rate
- HELOCs can be frozen or “called in” at any time which means you may have to pay the loan back on short notice
- If you can’t make your payments on your home equity loan, your lender could seize your home
- You have to pay back your home equity loan, so you’ll need to factor those payments into your budget
How does a home equity loan work?
To qualify for a home equity loan, you’ll need at least 20% equity or more in your home. You’ll also need a debt-to-income ratio no higher than 43%. Once you apply for your loan, it can take several weeks to be approved and you’ll need to submit to a detailed check into your credit history and employment. Also, you may have to pay fees like appraisal fees, title search, title insurance, and legal fees.
If you are over 55 and retired, a reverse mortgage, which is a variation on a traditional home equity loan, could be a good choice. With a reverse mortgage, you still use your home equity as collateral to borrow money, and you are still charged interest on your loan. But the biggest difference is that you don’t have to pay back your loan until you sell your home. You have to be at least 55 to qualify for a reverse mortgage, which makes this type of home equity loan ideal for retirees.
Alternatives to a reverse mortgage in Canada
Before taking out a reverse mortgage, consider some of these other ways to unlock the equity in your home:
1. Get a secured line of credit/HELOC: This type of borrowing is usually much cheaper than a reverse mortgage. You can access up to 65% of the equity in your home while you continue to live there and maintain ownership.
2. Become a landlord: Turn your home into a source of income by renting out a room or a basement apartment.
3. Sell your home and buy a smaller place, move to a cheaper location or invest the equity and rent.
Home equity loan vs. reverse mortgage
If you’re considering a traditional home equity loan or a reverse mortgage, it’s important to consider your needs when choosing between the two. A traditional home equity loan or HELOC will have a lower interest rate than a reverse mortgage, which makes them a better choice for those who want to keep their interest expenses low. However, if you are over 55 years old and don’t have a steady income, a reverse mortgage might work better for you.
Whatever you choose, it's important to remember to borrow prudently, and factor in the repayments (whenever they may occur) to your current or future budget. At Canadian Tailored Mortgage Solutions (CTMS), our experienced Mortgage Brokers and Agents can help you navigate the complex world of home financing and find the best mortgage options to suit your needs.
Contact us today to learn more! Get in touch with Canadian Tailored Mortgage Solutions now to unlock the benefits of mortgage refinance and take control of your financial future.
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