The promise of fast cash is always an alluring one. And as a homeowner, you may be bombarded with advertisements and offers to pull equity out of your home. The longer you’ve owned your property, the more cash you have access to. Borrowing against your home equity can be a way to access money for emergencies or investments. But it can also lead to unnecessary financial struggle and loss if used for the wrong reasons. In this article, we’ll take a look at when and why you should consider refinancing in a way that brings you closer to your financial goals.
Reasons to Refinance Your Home
Homeowners may decide to refinance for various reasons, some good and some bad. Taking out a second mortgage can be risky. Using those funds to buy a new car or enjoy a luxury vacation can seem irresistible in the short term but leave you in debt for years with no assets or equity to show for it.
However, if done correctly, refinancing can also be your ticket to financial success. Borrowing against your home to make renovations, buy a second property, or return to school can help you achieve your dreams and goals. In some cases, it can be well worth the risks involved. We recommend speaking with your financial advisor before applying for a home equity loan. If you decide to go ahead, a mortgage broker may be able to help you get the best rates and terms. Let’s examine some of the home equity refinancing options available to you.
Want to know more about debt and financing and how it all works? The posts below are a great place to start your research:
- Tips on Selecting a Mortgage Agent
- Drowning in Debt? Here’s What to Do About it Right Now
- Is Your Home Up For Financing? Here’s Everything You Need to Know to Get the Best Rate
Second Mortgage
A second mortgage in Canada allows you to borrow up to 80% of the appraised value of your home minus the amount owing on your first mortgage.
Let’s imagine that your house is worth $1 million. 80% of the appraised value works out to $800,000. If you have $500,000 left on your first mortgage, you can borrow up to $300,000 against your equity. ($800,000 – $500,000).
Like your first mortgage, you pay the loan in bi-weekly or monthly installments over time. What are the benefits of a second mortgage?
- Since the loan is secured against your property, there is less risk to the bank. As a result, the interest rate is often lower than on unsecured loans and credit cards.
- You can often access much larger amounts than with other types of loans.
- You can pay off your debts in small increments since the payments are spread out over a long period.
When considering a second mortgage, remember that the most significant benefit by far isn’t to you. The lender has the most to gain. You’ll pay more interest, and if you can’t make your payments, they can take your house! Yes, second mortgages can be risky. Plus, you still have your first mortgage to think about. Are you ready and able to simultaneously make two mortgage payments each month?
You want to be sure that your reason for the loan is a good one, not something that you’ll regret for years down the road.
Home Equity Line of Credit
Just like it sounds, a HELOC (home equity line of credit) provides you with cash against the value of your home. It’s similar to a second mortgage, except you get a revolving loan instead of a lump sum. You can pull out as much as 65% of the value of your home.
The advantage is that you will always have access to those funds. You can borrow only as much as you need and can pay it off at any time.
The bad news is that it can be very tempting to keep borrowing from the line of credit. The longer you take to pay it off, the more interest you accrue. HELOCs also tend to be variable loans, which means your rate can fluctuate. Your interest rate will increase whenever the Bank of Canada raises the prime rate. When the prime rate goes down, you will pay less.
A HELOC can be a good idea if you plan to use the funds on something that will pay off in the long term. For example, certain renovations and upgrades can add value to your home, which means taking out the loan might be worthwhile.
Cash-Out Refinancing
What if you don’t want another mortgage to worry about? In that case, you might consider a cash-out refinance where you replace your current mortgage with a larger one. Like a second mortgage, you can access as much as 80% of the appraised value of your home.
Once you receive the cash-out, you pay off your existing mortgage and keep the difference. The advantage is that it is often easier to keep track of your finances because you only have one monthly payment.
However, you could end up paying a steep penalty if you break your first mortgage by paying it off early. Before applying for a cash-out loan, check with your existing lender to see what fees you may be responsible for. Another factor to consider is the interest rate. When you refinance, you may pay more if rates have increased since you took out your original loan.
Investing in real estate is one of the smartest reasons to take a home equity loan. Here are some insightful resources to consider:
- A Complete Guide to Real Estate Investing in Guelph
- Growing Your Wealth Through Real Estate Even in a Recession
- Negotiating With Tenants as a Guelph Real Estate Investor
Reverse Mortgages
Are you close to retirement age and would like to have some extra funds on hand? A reverse mortgage allows homeowners over the age of 55 to access up to 55% of the value of their home minus the balance of the mortgage.
Reverse mortgages are unique because you don’t have to make monthly payments. You only repay the loan when you move, sell your home, or the last owner passes away. For some homeowners, these extra funds allow for a more comfortable retirement.
However, as with all refinancing options, there is a cost to consider. Even though there are no monthly payments to worry about, your equity in your home decreases. And the interest rate is higher on reverse mortgages than on other types of equity financing.
If you decide to use any type of home equity loan, be sure that you understand your reasons and what the outcome might be in the long run. Your local real estate agent or mortgage expert will be happy to guide you through your next steps.
Are you thinking about buying, selling, or investing in real estate and aren’t sure where to start? We have served the Guelph area since 2006 and would love to help you clarify and achieve your goals. Contact us today at info@gowylde.ca or call 519-826-7109 with any questions you have.
