By: Ian Mucignat
I enjoy simplicity. Here is an easy answer to the question: What exactly is “Equity”?
House Value minus Mortgage Balance = Equity
Many Canadians have been fortunate to have entered the real estate market over ten years ago -before the sharp rise in real estate prices. For these lucky homeowners, the value of their property has increased significantly while they were paying down their mortgage loans at ultra-low interest rates. These homeowners have generated some serious equity that is locked up in their property! This is equity that doesn’t have to be stuck in their house value and can be unlocked for use today. This is something that can be done with a financial product called a HELOC (a Home Equity Line of Credit).
Naturally, we might ask ourselves, why would anyone want to unlock this equity in their home?
Here are six good reasons why homeowners may want to unlock this equity:
Purchase an investment property
Equity can be used for a down payment or to finance the entire purchase. An investment property can generate income for retirement and cover its costs. Vacancy rates are very low, close to 1% in Toronto, and many economists see this being a persistent issue for renters, and opportunity for property owners. Furthermore, the interest on the loan is tax deductible.
Buy for kids – “do your givin’ while your livin’ so your knowin’ where it goin’”
Ever wonder how your kids are going to be able to purchase their first property when prices keep rising? Many parents are providing down payment support to their kids today to help them get a leg up. This is different from the traditional model where the wealth passes down through a will/estate.
Build an Emergency fund
Life happens! When an emergency arises and you need money, this is when it’s most challenging to be approved. It’s always better to seek credit when you don’t need it and have it ready on standby.
Fund a Cottage or Vacation property
This is similar to purchasing an investment property except that the property is for personal use. For the best of both worlds, your personal use property can also be rented out. Many owners enjoy some offsetting income earned through companies who help make this turnkey like Airbnb.
Pay for Renovations
Have you ever walked through an open house on a property that hasn’t had renovations for decades? Putting money back into the property helps improve the value of the property, and you get to enjoy those improvements for as long as you stay in the house.
Consolidate higher interest debts
Smart personal finance says to pay down your debts with the highest interest rate first. The rates on any debts that are unsecured, such as credit cards or term loans, are going to have higher interest rates than a loan secured by your home.
Smart finance also says you should spend below your means. If you are borrowing to pay for general spending, such as vacations, cars, dinners out, etc. then you are on a very slippery slope. Doing this with credit cards will have creditors knocking at your door quickly. Doing this with the equity in your home will “eat your house”.
Am I setting myself back?
When you first purchased your home, you made a down payment from your savings and financed the remainder with a mortgage. Your goal is to pay this mortgage off before you hit retirement. You might be asking yourself, “If I unlock the value of my property with a HELOC, am I setting myself back again?”
YES, if you are using the money to spend above your means or purchasing assets that lose value over time, such as a new car or boat.
YES, if you don’t have a plan for repaying the principal back and are stuck in a world of interest only payments.
NO, if you are using the money for investments like second properties. There is an expectation that these will gain in value. They can be sold in the future to repay the amount borrowed fully. This is much different than your principal residence where if you sell it, you still have to find a place to live/rent. For example, it’s highly likely that a cottage you purchase today can be sold for at least the same value, or more, in 5-10 years.
So, in cases like this, you are not setting yourself back in time financially with a mortgage. You are merely using your best asset (your home) as collateral for a loan to receive the lowest rates possible.
Further to the risks of borrowing to spend mentioned above, it should be noted that not all investments are created equal. Borrowing to invest in the stock market can be a much riskier proposition as the stock market can turn more quickly. By March of 2009, the Dow Jones Industrial average had dropped 54% from its peak in 2007. Ouch!
Work needs to be done to ensure that borrowing is done responsibly and address questions such as:
- How am I expecting to make payments?
- What are my expected returns and risks?
- What is my time horizon?
- What is my exit strategy?
Bottom line, if you have equity in your home and are financially responsible, then you might be a great candidate for a loan.
Keep calm and mortgage on!
About the Author:
Ian Mucignat, CFA, is an independent mortgage agent at TMG The Mortgage Group. He graduated from Wilfrid Laurier University with a Bachelor of Business Administration, minoring in Economics, and is a CFA Charterholder. Ian has worked in the mortgage industry since 2000 at lenders, banks, and brokerages. If you are purchasing, renewing, or refinancing your mortgage, don’t hesitate to contact Ian directly for a free consultation.