Let the Gains Begin: What Exactly is Home Equity and How Do I Access it?
Equity – NOUN – Def.
the value of a mortgaged property after deduction of charges against it.
If you own property in BC, in the last few years you’ve likely seen significant increases in the market value of anywhere from 20% to upwards of 40%.
And those are some serious gains.
So, what does it mean for you as a homeowner?
Well, on paper it increases your net worth and can be a potential source of funds to contribute to your future goals (such as retirement) provided that the property value holds. However, it’s important to remember that if you want to access that equity right away it will likely be in one of 2 ways:
1. When you sell your home, you realize the cash.
2. When you refinance your home, you access the cash.
And what is a REFINANCE exactly? By definition, it means to renew or reorganize the financing you already have in place. A refinance by any other name smells just as sweet, and some of the other monikers you might have heard thrown around before are: Equity Take Out, ETO, Refi, Home Equity Line of Credit, Home Equity Loan.
Basically, they all are a slightly different version of the same thing. But how does it work? Well, a refinance (or equity take out) allows you to access a portion of the equity you’ve built up through mortgage financing.
A Step by Step Look at How it Works:
-You approach your broker to discuss accessing some of this equity and once your broker understands your goals and the purpose of the funds, they recommend a refinancing solution.
-You and your broker estimate a market value for the property, which will generally be confirmed by some form of appraisal.
-Your broker will complete a full application, including reviewing a recent credit bureau, and collecting the relevant documentation (property documents, income documents, etc.).
-You can potentially take up to 80% of the property’s market value as equity, less any outstanding charges (and subject to qualification based on the property itself, your current income and your current expenses).
-In most cases, you will need to visit a lawyer or notary to have the new charge against the title registered (and this will be subject to legal fees), though some lenders offer programs to help offset these costs.
Sample Refinance Scenario:
Meagan and Jeff purchased a house in Aldergrove in 2019 for $700,000 with 10% down. The same house today is now worth $1.2MM, and they have an outstanding mortgage balance of $589,000.
Current value = $1.2MM
80% of current value = $960,000
Outstanding mortgage = $589,000
Available equity for financing = $371,000 ($960,000 - $589,000)
In this case, provided that they have the income and credit to qualify for the additional funds, they can take the $371,000 in new money as 1) A home equity line of credit with interest only payments 2) A second mortgage segment with new terms and conditions 3) Add the funds to their existing mortgage balance and renegotiate terms and conditions.
While it’s true that the total equity built up in the home is actually $611,000 ($1.2MM minus the mortgage of $589,000), if a lender were to advance this amount, they would be providing Meagan and Jeff with 100% financing, which is not something that is offered in Canada, more specifically on a refinance. If Meagan and Jeff want to access the full $611,000 to backpack around the world for the next 5 years, they would likely need to look at selling the property outright.
Some Common Misconceptions:
1. Can I access my equity without making a payment? The short answer is no. While there are some reverse mortgage type programs that can be explored if cash flow is a concern, when doing a refinance/equity take out you are essentially getting another mortgage and arranging new terms and conditions with the lender. Whether that new mortgage is an open credit facility (like a home equity line of credit) or a closed facility like a term mortgage, the lender is agreeing to lend you money for a specified period of time at a specified rate of interest, so you’ll need to factor that new payment into your overall budget.
2. Can I access all of my equity? Again no. The legislated maximum is 80% of the appraised market value of a property, as insured refinances over 80% were eliminated years ago in Canada. Currently, less than 20% down (high ratio) financing is intended to assist with the purchase of a home vs being used for refinancing purposes.
3. But it’s my equity, why can’t I just have it back? As long as there is a lender charge (mortgage) against the property then that charge has top priority, so the only way to realize all of the equity you have built in that property immediately would be to sell the property, pay off whatever is owed to the lender, and walk away with the cash. You could do this and use those funds to purchase a new property or park them in your bank account to do with as you please. But remember, if you’re asking a lender to give you money in exchange for putting a charge against the home that gives them the right to recourse if you don’t pay, then the consideration for that exchange is the cost of interest – the charge against the equity you’ve built up simply gives the lender some comfort that they could recover their money at a future date if necessary.
Refinancing can be an excellent way to access funds for the purchase of a secondary property/rental property, to invest in big ticket items (i.e., a child’s post-secondary education or that motorhome or boat you’ve always dreamt of owning) or to lower your cost of borrowing on other debts, but it’s important to keep in mind that the more debt added to the current property, the less equity that remains – so striking the right balance between your current lifestyle and future needs is key.
Questions? Let’s talk.