How are Canadians Using Their Home Equity?

When you buy a house and take out a mortgage, you make regular payments on that loan until it is completely paid off. A portion of each payment goes toward interest, and the rest goes toward the principal amount borrowed. As the principal on the loan gets paid down and the value of your home increases, your home equity grows. In other words, your equity is what you own outright or the difference between the value of your home and the amount you still owe on your mortgage.

There are several ways to access your equity and put those funds to work for you elsewhere. The most common options are a Home Equity Line of Credit (HELOC), a second mortgage, a reverse mortgage, and refinancing your home.

A HELOC is a revolving loan that requires regular repayments once the money has been accessed. Homeowners can draw funds as needed, up to the limit set by the lender. This limit is typically based on a percentage of the home’s appraised value, subtracting any outstanding mortgage balance.

A second mortgage allows you to borrow up to 80 percent of your home’s value – however, it will be at a higher interest rate. Second mortgages come in two main forms: a lump-sum loan or a Home Equity Line of Credit (HELOC). With a lump-sum loan, the homeowner receives the entire loan amount upfront and repays it over time with a fixed interest rate, resulting in predictable, regular payments. In contrast, a HELOC offers more flexibility, allowing the homeowner to borrow as needed up to a certain limit and usually has a variable interest rate.

A reverse mortgage is more commonly used by older homeowners. In this situation, the homeowner can borrow up to 55 percent of the home’s value. The unique aspect of this loan is that the homeowner does not need to repay the loan as long as they continue to live in the home and meet the loan’s requirements, such as maintaining the property and staying current on property taxes and homeowners’ insurance. Instead, repayment is due in one lump sum at the end of the loan period, typically when the homeowner sells the home.

Finally, refinancing your mortgage means that you borrow more than your current mortgage and up to 80 percent of your home’s total value. This means that you can borrow more money than the amount of your original mortgage.

These four types of equity loans provide many options for Canadians wishing to use home equity to improve their lives. Read on to find out how!

Top Ways Canadians Are Using Home Equity

Renovations

Home equity loans are often used to finance home improvements. Essentially, you’re using your home’s current value to increase its future value. The most significant benefit of using a home equity loan is that it usually carries a lower interest rate than credit cards or lines of credit. When using home equity for renovations, it is essential to consider the project’s cost, timeline, and scope.

Should the renovation be minor, not urgent, and something you can save up for in a few months, an equity loan probably isn’t ideal since you will have to pay interest on the money you borrow. However, if the renovation is a larger, more expensive project, a home equity loan is ideal because of the low-interest rate and the repayment flexibility.

Tapping into your equity to improve your home can be a good investment because you use the asset to enhance itself, increasing its value while not being charged excessive interest on the loan.

Purchasing a Second Property

Some homeowners use their home equity to move up in the market or to help them purchase a second property that may be used for rental income. This gives them more flexibility than taking a standard mortgage on the new property because, in some instances, you only have to pay back the interest and then can make payments as you desire (or a lump-sum payment) on the loan.

How NOT to Use Your Home Equity

While a home equity loan is helpful because it gives you access to a large amount of money for a lower interest rate than a line of credit or a credit card, these funds shouldn’t be used for non-essential items. Avoid using your home equity to cover daily expenses, vacation costs, or pay down credit card debt.

This type of loan carries interest, so if you’re using that to pay for non-essential items or daily expenses, you’ll be paying more than just the listed price. For these items, a better option would be to save up. Finally, using your home equity to pay off credit card debt is a double-edged sword. Yes, you will consolidate your debt and end up paying less interest overall, but it won’t solve the problem as to why you’re carrying credit card debt in the first place, and it increases the risk of this issue recurring in the future.

Home equity loans can be a great way to invest in a renovation, purchase a second property, or fund significant one-time expenses that you otherwise would not be able to afford. The lower interest rates and flexibility in the home equity loans available can provide tremendous benefits to homeowners. However, it is essential to consult with a financial professional to discuss all your options.

The Current Challenges with Building Home Equity

In the current economic climate, Canadian homeowners are facing considerable challenges in building home equity, largely due to the prevailing high-interest rates. These rates have significantly increased the cost of borrowing, particularly affecting those with variable-rate mortgages or those in need of refinancing. Consequently, a larger portion of homeowners’ mortgage payments is being directed towards interest rather than principal reduction, leading to slower equity accumulation. This situation means that, despite consistent mortgage payments, the increase in home equity is considerably less than expected.

Market volatility further complicates the situation. Fluctuations in housing prices directly impact the rate at which homeowners can build equity and, in some cases, may even result in negative equity, where the mortgage balance exceeds the property’s value. This volatility, coupled with the high-interest rates, has exacerbated affordability issues. The high cost of borrowing and soaring property prices challenge new buyers entering the market and strain existing homeowners who may struggle with increased mortgage obligations.

These challenges have long-term implications. Reduced equity growth limits homeowners’ ability to utilize their equity for financial goals, such as renovations, investments, or retirement planning. It also affects the potential profit from selling their home, impacting future housing upgrades or financial plans.

Looking to Buy a Home?

Despite the current economic challenges, building equity remains a crucial aspect of homeownership and financial planning. Homeowners are encouraged to explore strategies that could help mitigate the impact of high-interest rates, such as restructuring mortgages, making extra principal payments when feasible, and seeking professional advice to navigate these uncertain times. By adopting a proactive and informed approach, homeowners can still manage to build and maintain their home equity, albeit at a slower pace.

Are you planning to use your home equity to upsize your current home or purchase an investment property? Connect with a RE/MAX Agent near you.