If you own a Toronto home or condo, chances are you’ve amassed some equity in your property. Your home equity can serve as a financing tool for things like home renovations, paying for your child’s education or even buying more real estate. There are two ways you can borrow your home equity: by getting a Home Equity Loan or a Home Equity Line of Credit (HELOC). Let’s compare a HELOC vs Home Equity Loan.
WHAT IS A HOME EQUITY LOAN AND HOW DOES IT WORK?
A home equity loan, whether it’s in the form of a HELOC or Home Equity Loan, allows you to borrow against the equity you have built in your home. Using your home as collateral, it is a great way to borrow a large sum of money for a much lower interest rate than if you were to use a credit card or unsecured line of credit.
How Do I Know How Much Home Equity I Have?
Your home equity is based on two things: 1-how much of your mortgage have you paid off; 2-how much has your home appreciated? While there’s no magical home equity calculator, arranging a home valuation will help you determine your property’s fair market value and from there you can do the math.
For example, let’s say you bought a home in 2015 for $400,000 and have since paid off $150,000 of your mortgage. Additionally, the value of you home today is now worth $520,000, earning you $120,000 in equity. Your combined home equity is $270,000 ($150,000 + $120,000 = $270,000).
How Much of Your Home Equity Can You Borrow?
Assuming you have good standing financially, generally, the banks will allow you to borrow up to 80% of your home’s value, minus what you still owe on your mortgage. Using the example above, how much home equity would you be able to borrow?
(FMV) $520,000 x 0.8 = $460,000
$460,000 – (mortgage balance) $250,000 = $166,000 available equity
While an experienced Realtor may be able to give you an approximate home valuation, ultimately it’s the bank that will determine how much your home is worth for the home equity loan.
HELOC VS HOME EQUITY LOAN
The difference between a home equity loan and a home equity line of credit might sound complicated but it’s actually quite simple.
Home Equity Loan
A loan is a fixed amount of money in one lump sum paid upfront. With a home equity loan you’ll start paying interest on the loan the moment you take it out. For all intents and purposes, a home equity loan is a second mortgage.
So just like your existing mortgage, a home equity loan is set for a fixed term and interest rate which means you will have reliable payment terms and therefore no surprises.
Home Equity Line of Credit (HELOC)
When you have a home equity line of credit, you only pay interest on the funds you use as you use them. RateHub describes a HELOC as “a revolving line of credit secured by your home at a much lower interest rate than a traditional line of credit. In Canada, your HELOC cannot exceed 65% of your home’s value.”
In that sense, a HELOC is more like a credit card just without the steep interest rate, which can be around 9%. In Canada, HELOC interest rates are currently 4.45% (Prime plus 0.5%).
SHOP AROUND FOR THE BEST HOME EQUITY LOAN INTEREST RATE
You don’t need to get your home equity loan from the same bank or lender as your first mortgage. Be sure to shop around for the best rate. It doesn’t take more than a few minutes to do a quick search online. Websites like RateHub and RateSpy will list the best comparable rates for different banks and lenders.
WHAT CAN I USE MY HOME EQUITY LOAN FOR?
Ultimately, you can use your home equity loan for anything but be smart about how you use it. Because HELOCs have a lower interest rate than credit cards and other lines of credit, they can be a great way to pay off high interest debts.
Many homeowners use their home equity to make home renovations or even to pay for their kids to go to school. You can also use your home equity to build wealth through real estate. If you’re wondering if you can use your home equity to buy a second home or investment property, the answer is yes.
USING A HELOC TO BUY AN INVESTMENT PROPERTY
When it comes to building a real estate portfolio, a HELOC is a key financing tool to leverage your home equity and build more wealth. The concept of leverage is actually quite simple. In this video we show you how to leverage equity in your current home with a home equity line of credit and how that will equal more wealth in the long run. More debt can equal more money!
In the video we demonstrate the effects of leveraging equity using a HELOC versus outright cash to buy a $500,000 investment property. To buy the investment you will need a 20% down payment of $100,000.
Use $100,000 in cash
Borrow $100,000 in home equity at 4% per year or $4,000 in interest
You hold the investment property for five years and the value increases to $700,000 earning you $200,000 in equity.
Used $100,000 in cash to earn that $200,000 for a 200% return.
Used $20,000 of interest to earn that $200,000 for a 1000% return.
By leveraging your home equity, not only do you outlay less cash but you also get a much higher (5x to be exact) return on equity.
It’s important to note that there are some set up costs affiliated with getting a home equity loan or HELOC. Since you’ll need to determine your property’s current market value for the equity loan, you will have to pay for a home appraisal. This can cost around $300. You’ll also need to hire a real estate lawyer to register the loan documents that show it’s secured by your home equity. It’s best to budget around $1000 for your lawyer fees.
If you have equity in your Toronto house or condo and you’re looking to maximize your finances, to discuss the plan that is right for you. We have helped our clients build wealth through real estate — see some of our client returns here— by leveraging their home equity into real estate portfolios.
Pierre Carapetian Group Realty makes no warranty, express or implied, nor assumes any legal liability or responsibility for the accuracy, correctness, completeness or use of the information provided. Opinions are based on our own calculations and fair market value is as determined by us.