Owning property means so much more than a roof over your head. Equity is something most people don’t think about until they need it; as one makes their mortgage payments month after month, their appreciation grows increasingly favorable. Currently, many Canadian homeowners are shocked to learn that their amassed equity is liquid cash in their pockets.
It’s simple math. If your house is worth $500,000 and you owe $300,000, you’re sitting on $200,000 of equity. While lenders want to ensure that borrowers maintain 20% equity in their homes, a good portion of that excess can be accessed, and people are getting creative with how they make it work for them.
The Renovation Boom That Actually Makes Sense
Renovations are not a new phenomenon; however, the rationale for financing such endeavors has changed. Instead of saving money or relying solely on credit cards with oppressive interest rates for $50,000+ worth of kitchen remodels, additions of another bathroom, or basement finishes, people are diving into their home equity and reallocating thousands without an upfront cost.
While many renovations are for cosmetic purposes, they’re also increasingly for income-generating appeal. Finishing basements makes for rental units; adding additional bathrooms allows families to expand without outgrowing their starter home; updating plumbing that will eventually need to be done anyway, and costly down the line, provides families with not only an improved living experience but future appeal to buyers.
Ultimately, it makes fiscal sense to finance renovations through equity loans due to the lower interest rates compared to credit cards or personal loans; plus, renovated homes ultimately get assessed at higher values than the renovations initially cost. This isn’t necessarily guaranteed, but it’s better than doing nothing and allowing properties to depreciate while a homeowner saves a few dollars here and there.
School Borrowing When RESPs Fall Short
College costs are out of control. RESPs only take you so far, but when they’re exhausted and tuition bills still loom, some homeowners find it a better option to rely upon equity loans instead of student loans.
Equity loans have lower interest rates and more favorable repayment terms than student loans, the latter which children must take out in their names. Parents maintain control over equity borrowing, and avoiding excess debt on the child’s end truly gives a leg up before they enter adulthood.
It’s risky, if someone loses their job and can’t pay, they stand to lose their house over a student loan, but for families with stable incomes and plenty of equity, this has become a way to get children through school without exiting college with a mortgage-equivalent debt hanging over their heads.
Consolidating Debt That Actually Makes Sense
Credit cards are traps, and in many cases, the interest rates are so exorbitant that by the time someone makes a monthly payment, half of it goes toward interest and the other half barely dents the principal owed. It’s maddening.
But those sitting on home equity have an option. They can consolidate debt into their home loan and take their interest rates down into the single digits, this will allow them to save money because so little will go toward interest as compared to going toward paying off the actual debt.
Consider this: If someone has $30,000 worth of credit card debt at 20% interest, they’re paying almost $500 just in interest each month (not even making a dent into principal). But with home equity borrowing at 6%, it’s as little as $150 – $350 a month reduction makes all the difference in the world.
However, there is a downside, and it’s important to note. You’re converting unsecured debt into secured debt, credit card companies can’t take your house if you don’t pay them. Equity lenders can, as long as they take the necessary legal steps. So, unless someone is committed to never using their credit cards again, this isn’t the best option.
Funding Businesses Without Investors
Opening your own business isn’t right for everyone, but for many homeowners, access to small-business loans is not as easy as borrowing against their property value.
Why? Because banks don’t like new businesses, they want consistent revenue streams and established clientele bases before granting loans. However, if you’ve got enough equity in your home, banks are happy to grant those dividends. So, while it may be at risk of losing your house if your business goes under, for many people with great ideas but no other options to raise the capital they need, equity lending makes sense.
Of course, it’s risky; businesses fail all the time, especially when new, and if you’ve used your home as collateral and it fails, and you don’t have another job option lined up, you could lose everything you’ve worked so hard for over a failed attempt at starting something new. But for many, credit based on ability is unrealistic without prior ownership or experience in business fields; therefore, it’s the only option that makes sense.
Health Issues
Canada is known for its health care, which may be true for specific health needs but for anything other than rare prescriptions or procedures that require specialization (expensive dental work, etc.), some Canadians find themselves stuck facing medical crises without financial options.
Some homeowners borrow against their equity to cover medical costs, for example, fertility treatments that aren’t covered by OHIP but run upwards of $15K plus; dental work that is more cosmetic than corrective; medications that cost hundreds out of pocket per month, or thousands should they head south for specialized surgeries, which may be extensive but ultimately necessary quality-of-life procedures need funding somehow.
What Makes It Work (or Not)
Not everyone using home equity for major life expenses is smart, or stupid. Rather, it depends on the situation.
The people who make it work tend to have stable income, a solid repayment plan, and they’re using money for things that either generate value or create immediate solutions for problems that couldn’t otherwise wait. They aren’t doing silly things like using home equity loans for vacations or travel expenses or silly purchases, but rather improvements that fund quality of life for themselves or others first, and pay off interest later on down the road in increased value potential.
The people who get into trouble do so because they ignore reality, home equity is not free money; it’s borrowing against something you’ve worked hard for and unless you have rock-solid circumstances to make it happen and not blow it up in your face, you’ll ruin any chance you’ve had thus far living comfortably.
People also need to consider interest rates before they make changes; what might seem like a fair deal now could climb over the months and years, and even prior tenant purchase history complicates interest determinations, especially if you’re not even living in the house.
The Questions You Should Be Asking
The reality is there are hard questions worth asking before delving into new territory with home equity borrowing – including – but not limited to how much you’re willing to risk before taking that plunge.
What monthly payments can you afford if your income drops by 20%? What happens if property values drop in your neighborhood and you’re underwater? Is there an alternative way, and if so when would you explore it?
Relative timing is also imperative; how far away from paying off your mortgage are you? Years? If it’s five years until you’re mortgage free, and now you want to borrow an additional $150K, you’ll spend much longer working toward what should’ve come sooner easier.
Homeownership probably amounts to the largest asset you’ll own; therefore it’d be critical to use it as a vehicle to position yourself for opportunities big and small that otherwise wouldn’t be possible, but at the same time, it comes with great risk if you aren’t careful.
The homeowners who navigate this successfully are the ones who go in with realistic expectations all around about what’s possible versus what’s not worth it all.
