Home Equity: What is it and How do I Use it?
When you take out a mortgage to buy a house, it might seem like you’ve just taken on a huge amount of debt. But remember that you also have a valuable asset on your hands—your home. So although your mortgage debt roughly equals the value of your home, your overall wealth will not have changed by much.
To measure a homeowner’s financial wealth, there’s a useful concept called home equity. What is home equity, and how do you get it? It’s important to understand your home equity even if you don’t plan on ever selling your house.
Home Equity: What is it?
Your home equity is the amount of equity you have in your home. To find out the value of your home equity, subtract any loans outstanding from your home from its market value. If there are no loans against the house, then your home equity is equal to the full market value of the house.
A home’s equity is a useful indicator of your wealth, but it’s most often used to borrow money. Equity is an asset that you can tap into by taking out a mortgage, like a second mortgage or HELOC (Home Equity Line of Credit). We’ve covered these types of loans in more detail below.
How do I calculate the equity in my home?
Let’s say your home has a market value of $600,000. When you first purchased the home, you put a down payment of $100,000 which means your mortgage was $500,000. There are other costs associated with getting a mortgage but we’ll ignore them for simplicity. Your home equity would be calculated as:
$600,000 (home value) – $500,000 (outstanding mortgage) = $100,000 (home equity)
Let’s jump ahead ten years, and assume that you’ve reduced your outstanding mortgage amount to $300,000. Let’s also assume that the market has been good to you and that the value of your home has gone up by $200,000. Your equity calculation now looks like this:
$800,000 (home value) – $300,000 (outstanding mortgage) = $500,000 (home equity)
Your home equity is not strictly a measure of how much you’ve paid off your mortgage. As your home changes in value, your home equity will change with the real estate market. Of course, this also means that your home equity can go down over time, even if you continue to pay off your mortgage.
What is a home equity loan?
Home equity loans are among the most popular ways Canadians use home equity. A home equity loan is a type of loan where you borrow money using your home equity as collateral. Home equity loans are often used for large, one-time purchases like university tuition fees, home renovations, or medical bills.
Unlike an unsecured loan, home equity loans result in the lender being issued a lien on your home. This means that if you cannot pay your debts, your lender will be able to claim a portion of the sale of your home to cover the outstanding amount.
Home equity loans generally have a maximum size based on the appraised value of your home, for example 80 percent of your house’s value. What percentage can be borrowed depends on the type of home equity loan you’re using.
Types of home equity loans?
#1 – HELOC or home equity line or credit
A home equity line of credit (HELOC) is a special type of home equity loan that is bundled with your primary mortgage. It gives you the ability to borrow against the equity in your home, much like a credit card, but with lower interest rates and longer terms.
Instead of getting a large sum all at once, as you would with a traditional cash-out refinance, you can make periodic withdrawals from your HELOC account over the course of your mortgage term. The amount available to withdraw from that account is set at the beginning of your term, but your total credit available cannot be more than 65% – 80% of your home’s total value.
#2 – Second mortgage
Second mortgages are a popular option for home equity loans. They are exactly what they sound like—in addition to your primary mortgage, a second mortgage lets you borrow a portion of your home’s value as cash. The combined value of both mortgages cannot exceed 80% of your home’s value.
Second mortgages have much higher interest rates than regular mortgages. This is because in case of default, second mortgage lenders are lower priority than primary lenders and have to wait until after all other creditors have been repaid before they see any money. As a result, providers of second mortgages are exposed to higher risk.
#3 – Refinancing to access the equity in your home
When you refinance your mortgage, you have the option of borrowing more money from your lender. The maximum amount you’re able to borrow is 80% of the total value of your home. Refinancing often carries other fees and can result in a higher mortgage rate than you were charged on your old mortgage. However, one benefit of refinancing is that you don’t have to take out a second loan—some types of home equity loans require this.
#4 – Reverse mortgages
Reverse mortgages are a niche product—but they are also a kind of home equity loan, which many people use in retirement to supplement their income. These loans are exclusively used by older Canadians, generally as a way to fund their retirement when they don’t have enough cash or a pension to live comfortably.
Reverse mortgages allow people aged 55 and older to borrow up to 55% of the value of their home, either in installments or as a lump sum. There are no repayments required on a reverse mortgage until the loan comes due, which happens when you sell or move out of your home, or die.
The proceeds of the sale of your home are used to repay the loan. Like all home equity loans, reverse mortgages accrue interest over time at a rate that is generally higher than both regular mortgages and HELOCs.
Home equity is not a tangible asset, like cash in the bank, but it’s an important indicator of the wealth you have tied up in your home. In moments where you need to borrow cash, your home equity is one of the most important assets that you have.
Understanding what home equity is and what options you have to borrow against it are essential factors in modern financial planning.
Learn more about your home equity
If you’re thinking of accessing the equity in your home, or are curious about how much equity you currently have, reach out today to get the conversation started. My team and I can assess your personal situation at no cost to you and help you understand what your options are. If you’re ready to set up a HELOC or second mortgage then I can also find you the best deals and guide you through the process.
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