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Utilizing Home Equity Loans Wisely As A Smart Financing Tool
- By Barry James
- Published 04/28/2008
- Personal Finance
- Unrated
Barry James
For more information on home equity loans, or for advice and help in procuring a second mortgage, to help make your dream home a reality contact the professionals at Canadian Mortgages Inc. at www.canadianmortgagesinc.ca.
View all articles by Barry James
Second mortgages, or home equity loans, allow homeowners to take advantage of the equity they have built up in their homes to pay for home renovations, debt consolidation, start up or finance their small business or pay for their children’s education. As with any loan, there is a lot you should consider before signing on the dotted line.
How Much Can You Borrow?
You are borrowing against the equity you have built up in your home – that is, the difference between the current appraised value of your home and the amount you still have left to pay on your first mortgage. For example, if you have paid $50,000 of the principal owing on a first mortgage of $200,000, you can borrow against the $50,000 of principal you have paid off.
Many lenders will also allow you to borrow more than the equity you have built up under the first mortgage. Lenders will look at the total loan-to-value ratio of both mortgages combined. It is common for them to offer a total loan of 85% or more of the home’s appraised value. In the above example, if your home has increased in value from $200,000 to $300,000, you may be able to borrow 85% or more of the $150,000 in equity you have in the home ($300,000 current appraised home value - $150,000 in principal outstanding on the $200,000 first mortgage = $150,000 equity).
Risk Factors
Real estate properties can have multiple mortgages registered against them. The one that is registered first has priority and is known as the first mortgage. When a property is sold the first mortgage will be paid off in full before any other mortgage on the property is paid off. All other mortgages are said to be ‘subordinate’ to the first mortgage.
Second mortgages are seen by lenders as having a slightly higher risk than first mortgages and typically come with slightly higher interest rates. Why? Because they are subordinate to first mortgages. If the homeowner defaults, the first mortgage registered against a property is paid off in full before any amount is paid off on a subsequent mortgage. This means that the holder of the second mortgage can end up losing money if there is not enough equity left in the home to pay off each mortgage in full. Hence, lenders typically charge a slightly higher interest rate, as their risk of being repaid in full is slightly higher.
When Do Home Equity Loans Make Sense?
There is no standard answer to this question. The financial circumstances of every homeowner are different. A professional mortgage broker can help you analyze your current mortgage and your need for additional capital to help you come up with a borrowing strategy that is best for you.
If you are wondering if a second mortgage might be right for you, here are some examples of how they are used:
* Renovations – Use your home’s equity to finance major renovations.
* Debt Consolidation – Restructure your finances by borrowing against the equity you have built up in your home. The interest rates on a second mortgage will almost always be lower than that on a credit card, an unsecured line of credit or other consumer loan.
* Business Loans – Borrowing against the equity in your home is one possible solution for accessing capital to start up, refinance or provide a capital infusion for your small business.
* Investing in Your Family or Yourself – A home equity loan could be one solution for large one-time expenses, such as paying for your child’s education, covering the costs of a wedding or taking that once-in-a-lifetime family trip.
* Emergencies – No one likes to think about it, but if someone in your family suffers an accident or illness, accessing your built-up home equity could be invaluable in covering unanticipated legal, medical or other expenses.
Can You Save Money?
In certain circumstances second mortgages can help you save money.
If you owe money, you can use a home equity loan to obtain cash to pay off outstanding debts. You will be charged mortgage interest rates which are considerably lower than the rates charged for personal loans or credit card advances.
However, you should be particularly cautious about depleting the equity in your home just to pay off debts. Again, a mortgage broker can help you by providing the advice you will need if you are facing this often difficult decision.
How Much Can You Borrow?
You are borrowing against the equity you have built up in your home – that is, the difference between the current appraised value of your home and the amount you still have left to pay on your first mortgage. For example, if you have paid $50,000 of the principal owing on a first mortgage of $200,000, you can borrow against the $50,000 of principal you have paid off.
Many lenders will also allow you to borrow more than the equity you have built up under the first mortgage. Lenders will look at the total loan-to-value ratio of both mortgages combined. It is common for them to offer a total loan of 85% or more of the home’s appraised value. In the above example, if your home has increased in value from $200,000 to $300,000, you may be able to borrow 85% or more of the $150,000 in equity you have in the home ($300,000 current appraised home value - $150,000 in principal outstanding on the $200,000 first mortgage = $150,000 equity).
Risk Factors
Real estate properties can have multiple mortgages registered against them. The one that is registered first has priority and is known as the first mortgage. When a property is sold the first mortgage will be paid off in full before any other mortgage on the property is paid off. All other mortgages are said to be ‘subordinate’ to the first mortgage.
Second mortgages are seen by lenders as having a slightly higher risk than first mortgages and typically come with slightly higher interest rates. Why? Because they are subordinate to first mortgages. If the homeowner defaults, the first mortgage registered against a property is paid off in full before any amount is paid off on a subsequent mortgage. This means that the holder of the second mortgage can end up losing money if there is not enough equity left in the home to pay off each mortgage in full. Hence, lenders typically charge a slightly higher interest rate, as their risk of being repaid in full is slightly higher.
When Do Home Equity Loans Make Sense?
There is no standard answer to this question. The financial circumstances of every homeowner are different. A professional mortgage broker can help you analyze your current mortgage and your need for additional capital to help you come up with a borrowing strategy that is best for you.
If you are wondering if a second mortgage might be right for you, here are some examples of how they are used:
* Renovations – Use your home’s equity to finance major renovations.
* Debt Consolidation – Restructure your finances by borrowing against the equity you have built up in your home. The interest rates on a second mortgage will almost always be lower than that on a credit card, an unsecured line of credit or other consumer loan.
* Business Loans – Borrowing against the equity in your home is one possible solution for accessing capital to start up, refinance or provide a capital infusion for your small business.
* Investing in Your Family or Yourself – A home equity loan could be one solution for large one-time expenses, such as paying for your child’s education, covering the costs of a wedding or taking that once-in-a-lifetime family trip.
* Emergencies – No one likes to think about it, but if someone in your family suffers an accident or illness, accessing your built-up home equity could be invaluable in covering unanticipated legal, medical or other expenses.
Can You Save Money?
In certain circumstances second mortgages can help you save money.
If you owe money, you can use a home equity loan to obtain cash to pay off outstanding debts. You will be charged mortgage interest rates which are considerably lower than the rates charged for personal loans or credit card advances.
However, you should be particularly cautious about depleting the equity in your home just to pay off debts. Again, a mortgage broker can help you by providing the advice you will need if you are facing this often difficult decision.
