Keeping your home in the best shape possible should be a priority. Not only because you want your investment to become more valuable over time, but also because it is the place where you live, after all.
Smaller touches, like painting a room here and there, or landscaping, are lower-cost projects which can usually be paid in cash or with your credit card.
It gets trickier when you must take on a major project, such as redoing the kitchen or redoing your bedroom because of a water leak from the roof (which also needs to be fixed), for example. The bill on these renovations can climb to a few thousand dollars in no time.
What do you do in the event that you don’t have that kind of money available? There are a few options available to you if you need to borrow some additional capital to cover these costs.
The first thing to do is to find out how much equity you’ve built into your home.
Equity is the difference between your home’s current market value, as appraised by the lender, and the remaining balance on your current mortgage loan. If you owe $100,000 on a property with an appraised value of $300,000, the equity stands at $200,000. However, this does not mean that the entire equity on your home is at your disposal.
In Canada, the total of your outstanding mortgage loan balance and the amount you borrow against the equity can not exceed 80% of the property’s current market value.
In our example cited above, the maximum amount you could borrow would be $140,000:
Market value: $300,000
80% of market value: $240,000
Mortgage loan balance: $100,000
Equity available for refinancing: $140,000
Once you’ve figured out how much money you can borrow, you need to choose how you will go about borrowing this amount. There are a few options available to you, each with its pros and cons.
Option 1 – HELOC
A home equity line of credit, or HELOC, is a revolving line of credit guaranteed by your home. The interest rate on a HELOC is higher than a mortgage, but lower than a traditional line of credit (or a credit card). In Canada, the amount which can be made available through a HELOC is limited to 80% of the appraised value of your property; some lenders, however, will limit the amount to 65% of the value.
Using our previous example, you would be able to borrow a maximum of $95,000:
Market value: $300,000
65% of market value: $195,000
Mortgage loan balance: $100,000
HELOC maximum: $95,000
A HELOC works like a credit card. The entire credit amount is made available to you upfront. You can use as much or as little as you desire, and you will only pay interest (calculated daily) on the amount of money you withdraw.
As is the case with credit cards, you must make a monthly minimum payment on the balance of your HELOC. This minimum payment is equivalent to the amount of interest accrued on the amount borrowed. If you borrowed $10,000 on your HELOC, at 5% interest, your minimum monthly payment would be set at approximately $41.
A few things to remember if you’re considering a HELOC:
- You are not breaking your mortgage by opening a HELOC, which means you won’t need to pay a mortgage penalty or closing fees. However, the bank will need to appraise your property, and will likely pass the cost on to you. Also, in most cases, you will require legal services in order to register a HELOC on your property (some lenders will agree to pay for these services).
- The interest rate on a HELOC is a variable. It is attached to the prime rate, but its relationship to prime does not always stay the same. HELOC rates are set at prime + a number (current the most common adjustment is + .50%, but it could be higher or lower depending your situation and the lender) and your lender has the right to change that number at anytime, without prior notice.
- HELOCs are not offered by all lenders. Consult with your nesto mortgage advisor to find out if this solution is offered by your lender.
Option 2 – Contract a Second Mortgage
When you contract a second mortgage, you’re basically taking out an additional loan on a property which is already mortgaged.
This is the most expensive solution as it is riskier for a lender than the first mortgage. The lender of this second mortgage finds himself in second position on the title. If you default on your payments, and it goes into foreclosure, the lender of the first mortgage will always be paid out first.
This explains why, on average, interest rates for a second mortgage are typically set between 8% and 12%. Lenders will often charge a fee based on the amount of this second mortgage.
A second mortgage is used by borrowers who don’t have enough equity built into their property to take advantage of a HELOC. Borrowers interested in a second mortgage will need to qualify again for this loan dependant on the lenders criteria, and pay for all associated fees (appraisal, lawyer, etc.) either out of pocket or absorbing into the new loan.
Option 3 – Personal Loan
If you don’t have enough equity on your home, and lenders aren’t satisfied with your credit history, contracting a personal loan may be a valid option for you. A personal loan requires no guarantees or proof of insurance like a mortgage typically would, this is known as an unsecured loan.
Since it is unsecured, a personal loan will typically carry a higher interest rate. Additionally, there are no early payment penalties. You can decide between a fixed rate loan or a variable rate loan. Terms usually go from 1 to 5 years.
Option 4 – Personal Line of Credit
As opposed to a HELOC, a personal line of credit is not secured by the value of your property. Because the lender has no guarantee in the event you default on your payments, the interest rate will be higher than the rate on a HELOC.
In most instances, you can expect the interest rate on your personal line of credit to be set at prime + a few percentage points. The rate may therefore vary from month to month according to the prime rate.