If you’ve been paying off your mortgage for a number of years, you’ve been working toward increasing your home equity. Once you have enough equity built up in your home, you can tap into it and turn that equity into cash to fund home renovation projects, consolidate debt, fund life goals and more! If you’re in need of extra cash, this blog will help you learn more about how home equity works and how you can make it work for you.
How To Calculate Your Home Equity
Home equity is the amount of ownership of your home that you’ve built up through the years as you made your mortgage payments. It can increase in two ways simultaneously: As you pay down your mortgage and as the home’s market value increases.
To calculate your equity, take the appraised value of your home and subtract any outstanding secured debts against it (mortgage, home equity line of credit, etc.). The total amount that you can borrow must be greater than or equal to any outstanding secured debt on the home.
Calculating Loan-To-Value (LTV) Ratio
To calculate your loan-to-value (LTV) ratio, simply divide your mortgage balance by your home’s appraised value. An LTV of 60% means you have 40% equity in your home, which is helpful when qualifying for a refinance.
How To Utilize Your Home’s Equity
There are plenty of reasons why a homeowner may need to access their home equity over the course of time. Whether it’s a medical expense, tuition, emergency home repairs or a need to consolidate your debt, there are a few different ways you can tap into your home’s value so you can use the equity you’ve built over time to get the money you currently need.
Home Equity Loan
A home equity loan works similar to any other type of secured loan, but the main difference is that it uses your house as collateral. As part of this process, your lender will allow you to borrow a specific amount of money that’s based on the value of your home and you’ll be charged interest and have fixed installment payments to pay it back. In order to qualify, you need to own a house (which needs to be appraised by your lender), have paid off a significant portion of your mortgage and be financially secure enough to handle taking on more debt.
A home equity line of credit (HELOC) is a revolving line of credit that lets you borrow the equity in your home at a much lower interest rate than a personal line of credit. You’ll have to pay interest on the money you borrow through a HELOC but you’re able to borrow and repay over and over as you need cash, up to a certain maximum credit limit. The lender uses your home as a guarantee that you’ll pay back money you borrow. To apply for a HELOC, you must have at least 20% equity built up in your home.
A second mortgage is an additional loan you take out on a property that is already mortgaged. For lenders, taking on a second mortgage is risky as they’re in second lien position on your title. This means if you default on your payments and the property gets taken into possession, the lender in first lien position with the original mortgage will always get paid out first. Due to this added risk, rates for second mortgages are always higher than those for primary mortgages.
Specific requirements for getting approved for a second mortgage will depend entirely on your lender. Be sure to do your homework and understand what’s required of you to qualify and how that may differ by lender. Typically lenders will look at four areas across the board to determine if you’re a good candidate for a second mortgage: Equity, income, credit score and property.
A reverse mortgage is a loan that you secure against the value of your home that gives you access to tax-free cash without mandatory ongoing payments. It’s designed for homeowners who are 55+ and it enables you to convert up to 55% of your home’s equity into tax-free cash you can use to pay for travel, education, home improvements, debt or whatever you like. If you qualify, how much you will actually get approved for will depend on your (and your spouse’s) age, the location of your home, the type of home it’s classified as, your home’s appraised value, your home’s condition and how much equity you have accessible.
A mortgage refinance is the process of getting a new mortgage for your home, whether it’s from your current lender or a new one. You effectively pay off the first loan in full by using the second (new) one which allows you to lock in with a new interest rate and loan term. Keep in mind that this process will bring with it fees and penalties (typically around 3 months’ worth of interest) so make sure the benefits of doing a cash-out transaction outweighs these fees in the long run.
In order to pursue refinancing, both you and your home will need to meet some specific requirements regarding how long you’ve owned the home, what your credit score is, your financial history, how much home equity you have built up in the home and your debt-to-income ratio. While the minimum equity requirement varies by lender, you’ll typically need 15% – 20% equity to pursue refinancing.
Which Option Is Best?
Unfortunately, there is no such thing as the perfect overall choice when it comes to tapping into your home’s equity. To answer the question of which option is best, you’ll first need to determine what you need the money for:
– If you’re looking for a lump sum of cash to achieve other financial goals, a home equity loan or a second mortgage are most often sought out for homeowners who need a large sum of money immediately because these two options disburse all the money right at the start.
– If you’re looking to use the funds for home improvements or to start a business, a HELOC may be a solid choice as it provides access to cash periodically over the course of time. HELOCs are generally the most affordable type of loan in this situation because you only pay for what you borrow and just need to ensure you pay back the balance by the time the repayment period expires.
– If you’re looking to pay off other loans or credit card debt, a cash-out-refinance may be a good fit if your home has gone up in value. If your credit score is much higher than when you originally purchased the home, you’ll likely qualify for a much better rate which will help you compensate for the increase in monthly payments due to the cash-out portion you’re seeking.
Frequently Asked Questions
When it comes to accessing your home’s equity, it’s likely you’ll have a lot of questions. Here are a few common ones that may help give you a better idea of how the process works and what you can expect to encounter:
How much can I take out?
Each lender has limits on how much equity you can take out of your home, but typically you’re looking at 80% – 85% of your available equity. For example, if you have $250,000 in equity built up in your home to date, your lender may allow you to tap 80% of that to access $200,000. Be sure to speak with your lender in advance to learn more about their home equity limitations and procedures.
Are cash-out refinances tax deductible?
While mortgage interest isn’t tax deductible in Canada, you are able to deduct interest if the funds you cashed out were used to invest in income-generating assets. It’s important to consult a tax advisor if this is a strategy you are considering.
Can I use a home equity loan for anything?
Lenders typically don’t have limitations when it comes to what you do with the money you access through your home’s equity. They can be for necessities like paying an unexpected medical expense, or for things you really want but can’t currently afford like a dream wedding or family vacation. While you technically can use it to finance whatever you like, it’s always advisable to use it for refinancing high-interest debt (so you can get out of debt faster) or for home renovation projects (so you can increase the value of your home) so there’s an actual return on investment (ROI).
Whether you’re planning to borrow against the equity of your home or just want to learn more about what home equity is, there are steps you can take so you can access it in the future, should the need arise. Make it a point to check on your credit score regularly, create a realistic budget and understand all the costs/requirements associated with choosing to borrow against the equity of your home. It’s so important to consult a professional before you make any big decisions regarding your mortgage, as there are a lot of factors (and costs) to consider. Get in touch with our team to learn more about home equity and how you can put yours to work for you.