If you have equity in one or more of your properties which you would like to take out and put into good use such as investing (using equity to buy another house), paying down debts, renovating, using home equity to buy a second home, or to fund personal objectives, there are several strategies that you can use to access those funds.
There is no right or wrong way, and choosing an approach will depend on your particular situation, what you qualify for and any costs associated with the process compared to the benefits.
Here are the key strategies for equity takeout.
1. Home Equity Line of Credit (HELOC)
A HELOC is a line of credit that is secured against your property.
A line of credit can be setup individually on a property or in a second position after an existing mortgage.
The lender will require an appraisal and the amount of funds they lend you will be dependent on value
As equity accumulates into the property, you can go back to your lender and request and increase to the line. This is not done automatically, as you will have to submit a new application and qualify for the increase. Moreover, a new appraisal will be required.
2. Partial Refinance - Through a blend and extend
Another way to take out existing equity without impacting your existing mortgage is with a blend and extend strategy through the current lender that holds your first mortgage on the property.
Let’s say you a have a property that is worth $500,000 with a first mortgage in the amount of $300,000 at a rate of 2.99 per cent, maturing two years from now.
Your property has increased in value since you purchased it, as you bought in a high-demand area, and you completed some strategic renovations that helped to boost the value. You would like to access some of this equity to buy another property.
Assume that the lender’s mortgage rates today are 2.79 per cent for the three-year fixed and 2.89 per cent on the five-year fixed.
If the appraisal comes in at $500,000 and you qualify based on the lender’s guidelines, the lender will give you 80 per cent of the appraised value in funds; which equates to $400,000.
Since you currently have a first mortgage of $300,000 with the lender, this means that you now have access to an additional $100,000 in funds.
If the lender offered HELOCs or secured lines, they can definitely give you the $100,000 in that form, but another option would be in the form of a mortgage.
The lender can set up a separate first mortgage for $100,000 at the rate and terms you choose.
If you choose the three-year rate, your effective blended interest rate on the total funds can be calculated as follows:
($300,000 x 2.99% + $100,000 x 2.79%) / $400,000 = 2.94%
3. Full mortgage refinance
A full refinance means that you are looking to take out equity by breaking the current mortgage and increasing its current balance by the amount you are taking out.
If your mortgage is up for renewal or there are minimal or no penalties associated with breaking the mortgage, a refinance is an option to consider.
Refinances offer an opportunity for consolidating any non-secured debts, negotiating better interest rates with your lender and shopping for cheaper rates and better terms.
4. Equity takeout beyond what traditional lenders offer
The maximum equity takeout with traditional lenders (including banks, credit unions and trust companies) can be done through a refinance up to 80% of the appraised value of your property.
Any equity take out above the 80 per cent can be accomplished through private funding. You may be able to take out 90 per cent through private funding, depending on your personal situation and the location and/or condition of the property.
Should I choose a home equity loan or a HELOC?
If you’re confused as to which product will better suit your needs, ask yourself the following questions:
Q: Do I need the money in a lump sum or in several instalments?
A. If you need it in a lump sum, you should lean toward getting a home equity loan. If you need the money in instalments, lean toward getting an equity line of credit
Q. Is it for a long-term or short-term purpose?
A. If the money is to be spent on something that will last a long time, such as a roof or a car, an equity loan might be better. If the money is to be spent on something that won’t last long, such as a semester in college or a wedding and reception, you should think about getting an equity line of credit.
Q. How much of a monthly payment can I handle?
A. A home equity loan requires you to pay principal and interest every month for the life of the loan. A home equity line of credit allows you to pay just the interest for several years, if that’s what you want to do. It’s a whole other question whether it's a good idea to pay only the interest, and not the principal, for an extended period.
Our mortgage calculator can provide a more detailed picture as to how much you can borrow over how long.
Q. Would a line of credit tempt me to use the money carelessly?
A. Naturally, if you answer this in the affirmative, you should consider getting a home equity loan because you pay off the principal and interest over time, and it’s not a revolving credit account.