Home equity is a beautiful thing when you know how to use it. Here we look at how equity impacts your wealth and how to access it when you need it.
How Home Equity Works
Home equity isn’t as complicated as it sounds. It simply refers to the difference between your home’s current worth and how much you owe on your mortgage. In fact, the moment you make your down payment, you own that portion of the property outright. So, if the home costs $1 million and you put down 20%, you instantly earn $200,000 in equity. Not too shabby.
What Factors Determine Home Equity?
Home equity is not based on the price you paid for your home. Instead, it is based on the current value. That’s what makes home ownership such a good investment. In most cases, your mortgage balance drops, while your home value rises.
There are two factors to consider when calculating home equity:
- Mortgage balance
- Property appreciation or depreciation
While the first is straightforward, the second is impacted by a few factors, including:
- Current market value of homes in your neighbourhood
- Any upgrades you’ve made on your home that appreciate value
- Any negative factors, such as a leaky roof or foundation, that depreciate home value
- How to Calculate Home Value
Calculating home value is not math 101. Your mortgage payments include both the interest and principal portion. So, your equity is calculated using the principal portion only. Let’s apply a two-year period to the above example to see what that looks like:
- Initial mortgage balance: $800k
- Mortgage payments at 4% interest: $4,208 a month
- Total payments made over 2 years: $100,995.88
- Total interest paid over 2 years: $62,011.35
- Total principal paid over 2 years: $38,984.50
- New mortgage balance: $761,015.54
- Current home value: $1.2 million
- Total home equity: $438,984.46 (1.2 million – 761,015.54)
The maximum amount you can qualify for is 80% of the equity – $438,984.46 x 80% = $351,187.57
Of course, these numbers all depend on the market and current interest rates.
Whether you’re a new homeowner or you’ve owned your home for a long time, here are some more posts you might find helpful in the future:
- How to Fix a Badly Flipped Home
- 12 Interior Design Elements that Never Go Out of Style
- Will Home Improvements Increase Property Taxes?
How to Leverage Home Equity
You can only borrow up to 80% of your home equity and only if you qualify. Here are a few examples of the most common home equity scenarios:
How to use home equity to buy a new home
In this scenario you’re ready to make a move, selling your current home and buying your next. If you don’t have savings for the down payment, you can use your home equity. When timed right, the transactions to sell and buy happen at the same time, and you can use your $351k for your down payment. If you sell after you buy, you can request a bridge loan from your bank. This loan funds your down payment, and then you use your profits to pay the bridge loan off right away.
Questions about buying a home in Toronto? Read these posts next:
- How Much is a Down Payment on a House
- What Does Conditionally Sold Mean?
- Who Pays Land Transfer Tax in Ontario?
How to use home equity to invest in real estate
You can apply for a home equity line of credit (HELOC) to invest in a rental property. Your $351k can be used to pay off a fair chunk of the home, and then your tenants pay your mortgage. Nice!
Before you jump into the investor pool, read our post about how to juggle career, family, and real estate investing right here.
How to use home equity to build wealth
Wealth building uses the same strategy as a real estate investment. A HELOC funds your investments. This is regarded as “good debt,” as the loan is growing your net worth as opposed to acquiring bad debt by purchasing things that offer no ROI such as clothes, extravagant meals, or trips.
How to use home equity to retire
There are a few ways you can use your home equity to finance your retirement, including:
- HELOC loans to fund investments or expenses as needed
- Downsizing to a more affordable home to either eliminate mortgage payments by paying cash from your home equity or reduce mortgage payments by making a sizable down payment
- Using a tax- and payment-free Canadian Home Income Plan (CHIP) to access home equity to finance your retirement spending
Are you helping your parents retire? Read our blog series about helping your parents downsize here:
How to use home equity for home improvements
There are two ways to use home equity for home improvements:
- HELOC: The line of credit has a draw period to fund the costs and a repayment period once the renovations are complete. You only use the money you need, reducing how much interest you pay. On the negative side, HELOCs usually have a variable interest rate, so your monthly payments can go up and down, making budgeting more challenging.
- Home equity loan: A home equity loan provides a lump sum to pay for your improvements. This is often the better choice, as you can request a fixed rate to make regular payments. Also, if you don’t use the entire lump sum, you can pay that amount back right away. On the downside, the interest is applied to the entire lump sum, AND you start repaying the loan pretty much right away.
Home equity can help fund investments, your next home, renovations, or retirement, making it one of the best ways to build your wealth. We can assess your home to accurately calculate your current home value. You can also reach out to your mortgage broker to see if you qualify for a home equity loan if this is something you’re considering.
Looking for real estate advice? Trust the top real estate agents at The Christine Cowern Team. Give us a call at 416.291.7372 or email hello@christinecowern.com to get in touch today!