What is Home Equity?

HOME EQUITY refers to a homeowner’s actual ownership stake in a piece of real estate or a house or the portion of the house that genuinely belongs to the owner. In the long run, owning a house gives you the opportunity to accumulate equity, which is the most valued benefit of homeownership.

The gap between the market value of a home or property and the amount owing on the owner’s mortgage is the true monetary value of the owner’s equity in the property. Initially, equity in a property is built up through the down payment made during the purchase, and its value increases over time as a result of regular mortgage payments made on time.

For example, if the home’s purchase price was $1,000,000 and the buyer paid a 20% downpayment and financed the rest $800,000, the buyer would have $200,000 in equity at the time of the transaction. However, as time passes and buyers continue to make regular mortgage payments, the amount of money the owners have invested in the home grows, and the value of their home equity rises.

Basically, when the following scenarios are met, the financial worth of home equity increases:

• Owner pays down their mortgage
• if the value of the home increases.

Homeowners with equity in their property may be eligible for some of the most incredible lending options. Loans secured by a homeowner’s equity typically have lower interest rates than other types of loans. A wide range of home equity finance solutions and options are available from various financial organizations. Therefore, it would be excellent to do some comparison shopping during your research period. It is possible that you would be required to go through a qualification process before being approved to borrow against your home equity, just as you would have to with any other credit or financing option.

Based value of your equity, a lender can provide refinancing in the form of a second mortgage, a home equity line of credit, i.e. HELOC, or other loan or line of credit secured using the home as collateral.

Fees & Interest Rates for Home Equity

Loans or credit secured by a home’s equity will have different interest rates depending on the type of loan, borrower’s credit history and type of lending institution used to secure it. Furthermore, it can be different from the initial first mortgage on the property or home.

Administrative charges such as appraisals, title searches, title insurance, and legal fees may also be incurred during this refinancing process.

Home Equity Loan or Second Mortgage

In the case of a home equity loan, also known as a second mortgage, the homeowner might borrow against the value of their house’s equity as a second loan. The difference between current market value and the homeowner’s outstanding mortgage balance is the basis for calculating loan size. In most cases, the home equity loan will be backed by a mortgage placed on the property’s title and will be paid out in a single lump payment. To get a loan, the amount of equity you have built up in your house will decide how much money you can get. Using a second mortgage, you can borrow up to 80% of the appraised value of your home, minus the amount payable on any prior mortgages. Interest rates for a second mortgage can either be fixed or variable rates but are generally higher than the first mortgage.

Even as you work to pay off your second mortgage, you should continue to make payments towards your first mortgage. A lender has the option of seizing and selling the property if you fail to make payments on these loans on time. In order to pay off both your first and second mortgages, the lender will put up your house for sale. To clear out the debts, the homes sale amount is used to pay the first mortgage followed by the second mortgage.

There are various reasons why people use second mortgages, such as home upgrades, college educations for their children, an emergency fund, and more. 

It is common to use a second mortgage in order to invest, such as purchasing a rental home or buying a second home. Instead of putting 20% down, you can use the equity in your current house as a down payment. Additionally, you can deduct all interest payments from your taxes as expenses if utilizing a second mortgage to invest.

Home equity line of credit (HELOC)

Home equity line of credit, i.e. HELOC, is a type of secured lending where your home serves as a guarantee. It is a revolving credit, which means that you can obtain it and then borrow money at any moment, repay it, and borrow it once again, up to the credit card’s maximum credit limit.

There are two main types of home equity lines of credit: one that’s combined with a mortgage and one that’s a stand-alone product.

Home equity line of credit plus mortgage

Home equity line of credit combined with the mortgage combines a revolving home equity line of credit and a fixed-term mortgage. Being the borrower, you can borrow a maximum of 65% of the home’s market value.

For Home Equity Line of Credit, the lender will generally require you to pay interest on the money you use, and there is no fixed repayment amount. For fixed-term mortgage payments are required regularly based on amortization terms and schedule towards the mortgage principal and interest. Your home equity line of credit normally appreciates in value as you make mortgage payments.

You can use this for your next investment to buy a home, where you can finance a part of that with a home equity line of credit and other portion with a fixed-term mortgage based on lenders’ advice. 

To be able to use your equity to purchase your next home, you must have at least 20% equity in your current property. Your home equity line of credit can only finance up to 65% of the value of your property’s market value, so plan accordingly. If you want to borrow up to 80% of the home’s market value, you must finance anything above 65% using a fixed-rate mortgage.

Further, you may be able to set up loans such as personal loans, credit cards, car loans, business loans etc., within your home equity line of credit combined with a mortgage. They can have different interest rates and terms than your home equity line of credit.

Stand along home equity line of credit

This stand-alone home equity line of credit is the type of revolving credit secured against your home and not tied to your mortgage. For this, you can borrow a maximum of 65% of the value of your house. This credit limit does not increase when you make payments on the principal balance of your mortgage. You can use it to purchase your next home or investment property since it provides flexibility, as you can utilize the funds without any prior fixed repayment schedule. Additionally, you can repay at any moment or even pay it off in full without incurring a prepayment penalty. If you plan to use this to purchase your next home, you will be requested to put down at least 35% of the purchase price as a deposit.

Reverse Mortgage

A reverse mortgage is a type of mortgage loan that allows you to access the equity in your home entirely tax-free without having to sell it first. It can be referred to as “equity release,” in which the lender provides you with cash in exchange for your portion of the equity in your home. You may be eligible to borrow up to 55% of your home’s current market value. However, unlike other types of mortgages, you are not required to make any payments on a reverse mortgage until when the loan is due. When you leave your home permanently, sell it, or the final borrower passes away, you are responsible for repaying your loan. In case of the death of the last borrower, their estate has to pay back the remaining debt. 

You must own a property and be at least 55 years old to qualify for a reverse mortgage. Before obtaining this mortgage, all existing loans or lines of credit secured against your house have been paid off and closed, including your mortgage and a home equity line of credit.

The maximum amount you will be eligible to borrow will be determined by your age, the value of your property, and the lender. The interest rate on reverse mortgages is higher than other traditional mortgages.

And, The interest on this loan keeps accumulating as time passes, which sometimes can result in losing or reducing the equity you own in your home. Usually, no monthly interest or principal payments are required until the loan’s due date of the debt matures, in contrast to other types of mortgages. You have the option to pay off your loan in full at any time during the period of the loan, including interest and principal. But, paying up your reverse mortgage early, on the other hand, may entail paying a prepayment penalty cost. Whether you sell your property, move out of your home, the final borrower passes away, or you default on your loan, you are responsible for repaying the amount owed. In case of death of the borrower, debt has to be paid by their estate in a set period.

Reverse mortgages are available in Canada from two banking organizations. The Canadian Home Income Plan (CHIP) is offered by HomeEquity Bank, while Equitable Bank provides a reverse mortgage.