A New Look At Home Equity Loans
March 7, 2011 § Leave a comment
By Amy Brown-Bowers ~ Bankrate.com
Nearly one out of every five mortgage borrowers in Canada took equity out of their home in the past year, with the average estimated amount being $46,000. Added up, that means that the total amount of equity “take-out” for Canadians during the past year has been $46 billion. These statistics, which come from a recent Canadian Association of Accredited Mortgage Professionals (CAAMP) report, reveal just how prevalent home equity loans are.
Home equity loans in simple terms
In the simplest of terms, a home equity loan is when you subtract your outstanding mortgage from what your home is worth and borrow some of the difference. The process of getting a home equity loan “is the same as getting a mortgage,” says John Panagakos, principal broker at The Mortgage Centre in Toronto, adding you complete a regular application, submit to a credit check, and provide income verification.
There are generally two types of these loans: a home equity loan and a home equity line of credit. The difference is that you can continue to withdraw from and pay back money on a home equity line of credit, whereas with a home equity loan, once you have used and paid back the money, the loan is gone.
Panagakos refers to the latter as a “collateral loan,” and says that the “preferred method is the equity line of credit because you can draw on it, pay it down, then use it again,” giving borrowers more flexibility.
Recent regulation changes
In the past, Canadian regulations allowed for what were called “high-ratio” home equity lines of credit. These loans were meant for people with expectations of higher income over time — for example, a newly graduated doctor — thus allowing them to borrow more than their current circumstances would typically allow.
However, Canadian Finance Minister Jim Flaherty recently announced changes to mortgage rules that directly apply to home equity loans. Until March 18, 2011, Canadians will be able to refinance up to 85 per cent of the value of their home but as of April 18, 2011, that will be further reduced to a maximum of 80 per cent. Thus, moving forward, “there will be no more high-ratio home equity loans available,” says Panagakos.
When are they useful?
According to CAAMP’s November report, the most common use for money borrowed from home equity over the past year was home renovations, accounting for $15 billion, or 33 per cent of the total national take-out amount; debt consolidation and repayment accounts for $13.5 billion, or 29 per cent of the total take-out.
“A home equity line of credit’s flexibility is its main advantage compared to other mortgages, and when used responsibly, offers the borrower a long-term mortgage and line of credit arrangement without having to re-qualify when they wish to tap into home equity,” says John Thompson, senior vice president of product development and strategic initiatives at MCAP Service Corporation, an independent Canadian mortgage and equipment financing company that recently launched a new home equity line of credit called Home Account.
“This is especially handy when paying for school tuition, a family vacation, home renovations, RRSPs or other financial investments, buying a car or even a cottage,” he says.
Thompson adds that this type of loan “tends to be for the more experienced homeowner who values paying off their mortgage faster if possible, but is aware that it’s a really efficient way to borrow money at a very good rate.”
Is it for you?
Panagakos offers some helpful questions to ask yourself when trying to determine if this is a good option for your family:
- Is this a short-term loan?
- Is it for an investment that will generate more revenue than the interest on the loan?
- Are you planning to use the money to renovate and possibly sell soon?
If you answer yes to these questions, a home equity loan may be worth considering.
Home equity loan red zones
While borrowing against the equity in your home can make good sense, be careful that you are not using a home equity loan to pay for daily expenses, such as groceries or utilities or other ancillary bills.
“[These] are not for the homeowner who believes that this allows them to use the equity in their home like a bank machine, or for default management purposes,” says Thompson.
In other words, carefully consider the purpose of the loan and have a specific investment or goal in mind when considering this product. Think of it as an investment tool, not as a way to fill gaps in your regular budget.
Amy Brown-Bowers is a writer in Toronto.