If you’ve been paying your mortgage for several years now, you may find yourself receiving marketing materials about home equity loans available to you. Your home equity is the difference between the current value of your home and the amount you still owe on the mortgage; as time goes by, your equity should increase over the long term – for two reasons.

The first, of course, is the gradual progress that you make each month with your payment. In the early years of your mortgage, the vast majority of your payments go to satisfy the interest expense of the loan, with just a small fraction eating away at the principal, or the balance due. With each payment, though, the proportion shifts gradually, with more going to principal and less going to interest.

The second reason your equity will build over time is that home values have historically risen over the long term. There have been corrections, of course. One example came in 2007-2008 when the Great Recession happened as the result of poor lending standards and subsequent defaults, but generally speaking, home values rise. While the return varies depending on location and other factors, the Canadian historical average has fallen between a five and seven per cent annual increase in the value of a home.

So should you tap that equity and take out a home equity mortgage against what you’ve already paid in? We’ll talk about the process and some factors for you to consider.

Applying for a Home Equity Loan

Taking out a home equity loan involves a similar process to applying for other kinds of loans. The lender will require documentation and will use that information, along with a property appraisal and a credit report, to evaluate your application. Here are the most common steps that people follow when applying for a home equity mortgage.

  • Decide how much you want to borrow. In Canada, traditional lenders can only extend you up to a 65 per cent loan-to-value ratio if you decide on a home equity line of credit (HELOC), and it is rare to get approval for more than 80 to 85 per cent LTV with a home equity loan. The difference between the two is that a HELOC is a credit line that you can access a bit at a time if you choose, while the loan comes as a lump-sum payment.
  • Take a look at your current credit status. You can get free access to your credit report without influencing your score. If you’re not in the mid-600s, approval from traditional lenders (banks and credit unions) could be an issue, so you might want to look at private mortgage solutions. If you’re in the mid- to high-600s but want to qualify for premium interest rates, you might want to take a few months to boost your credit score even higher.
  • Shop around for the best rates and cost structure. Obviously, you can always go with the bank that issued your first mortgage, and if you also have checking and savings accounts there, you can often leverage that into a premium deal on a home equity loan or HELOC. However, it’s a good idea to look at multiple banks and credit unions to see where you can get the best deal. You want to look at the fee structure in addition to the interest rate, because closing costs and other administrative fees that lurk down in the fine print can make a loan that’s slightly lower in interest rate end up costing more because of the hidden fees.
  • Start the application process. Most lenders allow you to apply in person, over the phone, or online. Such basic details as your contact information, your planned purpose for the loan, permission to perform a credit check, documentation about current debts and assets, and proof of your current income are all part of this process.
  • Pursue the underwriting process. Moving from application to closing can take 30 to 60 days in most cases, although private mortgage solutions can sometimes move more quickly, depending on the situation. The underwriting team will go over your information and may ask for further detail. This process may also include a property appraisal. If your information meets the lender’s specifications, they will approve the loan and set a closing date.
  • Receive the funding. The last step involves signing a repayment agreement and closing the loan. You will want to read the disclosure thoroughly so that you understand all of the associated fees, costs, and other obligations. After closing, the lender sends the funds into the account you have designated.

Utilizing Funds from Home Equity Loans

Once you receive the funding, you can use it however you choose. Home equity loans and HELOCs come with lower interest rates than credit cards, personal loans, and other forms of unsecured debt, so consolidating those higher-interest debts with home equity funding can make a lot of sense. You can use it to pay for medical expenses, college expenses, remodeling projects, or even a vacation home or a boat. There are no restrictions on how you spend the money.

FAQs on Home Equity Loans

What is the LTV ratio?

This ratio has to do with the amount of your debt owed on a home to its current value. Let’s say that you bought a home for $440,000 and have paid the mortgage down to $200,000. Since you bought the home, it has increased in value to $600,000. You currently have an LTV ratio of 33.3 per cent (the amount due divided by the present value). Your maximum LTV ratio with an HELOC in Canada (65 per cent) caps your total amount owed at $390,000, so you could qualify for an HELOC for as much as $190,000 depending on closing costs and fees. With a lump-sum loan, if you can quality for an 85 per cent LTV ratio, you could push your debt up to $510,000 in total, making a total loan (including fees and costs if you roll them into the note) as high as $310,000.

What if banks reject my application for a home equity loan?

If you’ve been paying your primary mortgage on time but your debt ratio has gotten a bit out of hand thanks to credit card balances, then your credit score may have dropped below what your bank or credit union will accept, and getting a home equity loan through that entity may not work – even though you could resolve your total debt faster thanks to the lower interest rate. This is a situation that the private mortgage lenders Toronto and other cities feature can sometimes remedy.

In case you are wondering how private money lending works, any individual or business entity can invest in real estate by funding mortgages themselves. In Ontario, a Private Lender must be a Brokerage or run through a Brokerage. You will face a higher interest rate because the lender understands that the borrower cannot get approval through traditional channels. In this situation, the borrower represents a higher degree of risk – and therefore has to pay the loan back at a higher interest rate.

What benefits do private lenders offer with home equity funding?

Even so, the private mortgage lenders Toronto and other cities have will often offer home equity loans at a lower interest rate than what borrowers are paying for their personal loans and revolving debt. So while the savings might not be as significant as they would be if the home equity funding came from a traditional lender, the difference in interest rate may still be high enough for the costs associated with the private loan to be worth it.

Private mortgages tend to have short terms, often no longer than 12 months. In most cases, the payments are interest-only, with the principal paid  in full at (or before) the end of the term when the borrower secures another home equity loan from a traditional lender. During the term of the private loan, the borrower has time to clean up their credit score so that approval will be possible when the private loan term comes to an end. Many borrowers have improved their financial situations by starting with private loan providers and using that time to benefit from the funding, either to go ahead and move into a new home or get an equity loan on the property they own and work on improving overall credit. There are other uses that Private Lenders are used such as taking care of CRA Debt, Wirts, Judgements, and Consumer Proposal Debts that Traditional Lenders simpy are not interested in. Private Lender do not generally report payments to the credit bureaus. However, traditional lenders will factor in the repayment history with the Private Lender when determining if a new loan will be granted.

Private Investors and Lenders have many similarities, but differences can also differ significantly depending on the Lender. At Amansad Financial, we work with a network of Private Lender Partners that have a baseline lending appetite with some flexibility in different areas. For further clarity on our Lending, read https://amansadfinancial.com/common-private-lending-questions/ and https://amansadfinancial.com/common-appreciation-mortgage-lending-questions/.

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