Home Equity Loan
What is a home equity loan?
A home equity loan is a mortgage loan that your borrow money by using equity of your home. Whether you can be approved for a loan is dependent on your ability to make the required monthly payment and your credit standing.
Should you get a home equity loan or refinance your mortgage?
You should consider your personal situation, and which option works better for you. If in doubt, check with your bank or a mortgage broker.
Generally, a home equity loan is granted by your bank that already holds your 1st mortgage. You loan can be a conventional or high-ratio loan. When the combined value of your 1st and 2nd mortgage loans is more than 75% of your home value, it is a high ratio loan. The loan amount you can access is the total new mortgage loan approved by your bank, less any prior outstanding prior charges. Depending on your income, you may be approved up to 90% of your home value.
A home equity loan is secured by your home, you are required to repay the loan in full if you sell your home.
The loan allows you the flexibility to use your available credit to:
- Consolidate debt - pay off high interest credit card debts
- Do home renovations
- Take a vacation or purchase a vehicle
- Buy a business or another investment property
- Take advantage of investment opportunities
The most common reason why a home owner applies for a home equity loan is to pay off high interest credit card debts. Typically, if you have $50,000 of credit card debts and other personal loans, you are required to pay at least $1,500 a month to keep your accounts in good standing.
By consolidating your credit card debts and personal loans with a home equity loan, you only need to make a single monthly payment around $300. You improve your cash-flow by $1,200 a month. You also save interest payments on your high interest credit cards. You have the option to have your loan as a fixed rate loan, line of credit loan or a combination of the two.
1) Home Equity Line of Credit - Revolving Loan
Home equity loan can be in the form of a Line of Credit, sometimes called HELOC. This is simply a revolving line of credit. Once your loan is set up you can reuse your available credit up to the limit of the loan just like a credit card. Your monthly interest payment is dependent on the loan amount outstanding. You have the flexibility of pay the interest only on the money you used, or you can pay off more of the money you owe. The interest rate payable for your loan may be set at Canadian Prime Rate or below Prime Rate. Different Canadian banks have their own interest rate structures under their HELOC program.
2) Fixed Rate Loan
Some home owners may prefer to have their home equity loan on fixed term with monthly repayment of principal and interest. When a fixed rate loan is approved, you pay a single, lump-sum monthly payment. The loan is to be repaid over a set time period just like a first mortgage loan. The monthly payment of principal and loan interest rate remains the same over the term of the loan.
Deduction of Interest Payment
Whether you can claim deduction of your interest payment on your home equity loan depends on how the money from you loan is used. When the money you take out from your home is used for investment purposes, the interest payments for your loan are considered as an expense and booked as “carrying costs”. The interests paid on your loan can be claimed as expenses, and eligible for deduction against your investment income.
When the money from a home equity loan is invested in a high return income producing investment, a home owner can increase his monthly income and cash-flow.
For example, if the interest rate payable for your home equity loan in is at 5.50%, and your investment returning 12%, your $300,000 investment capital loan can generate a monthly income of $3,000. After deducting your interest payment of $1,375 , you have $1,625 a month extra income at your disposal.
For home owners who have the access to their home equity Line of Credit, they can use the extra income to pay off their home mortgage much sooner.
You can consider investing your money in stocks, mutual funds, bonds or private mortgages. Or, you can choose to have a hand-off investment in an established Mortgage Investment Corporations (MIC) which may pay between 10% to 12% after deducting management fees.
For more information, you can call James Wong at 604-721-4817 for a discussion.