Are you considering a home equity loan to fund your home renovation? Whether you’re updating one room or the entire house, it’s important to weigh your borrowing options, closely monitor your renovation budget and keep your debt load in mind.
Spending more time at home, wanting to increase their home’s value, and even having more disposable income are just a few of the drivers that are motivating Canadians to take on home reno projects.
Research firm Abacus Data found that 44 per cent of Canadian homeowners, aged 30 to 44, have or are considering home renos during the pandemic.
A home equity loan or line of credit is a type of secured debt, which means it is debt that is backed by an asset – in this case, your home. You can determine how much equity you have in your home by subtracting what you owe on your mortgage from your home’s market value. For example, if your home’s market value is $500,000, but you still owe $400,000, your equity is the difference: $100,000. If you have enough equity in your home, you may be able to borrow a percentage of your equity.
Before you get caught up in the excitement of updating your home, first consider the cost. Here’s where to start:
Speak to a few contractors in your area who can draw up a quote based on what you have in mind.
Create a budget that includes the cost of materials, labour and anything new you’ll be adding to your newly renovated area such as lighting, sinks, furniture or appliances. Add 20 per cent to that number, just to be safe. It’s also a good idea to account for any disruption to your normal routine during construction. For instance, if your kitchen is being renovated, set money aside for takeout meals while the work is being done.
If you’re planning to rely on your home’s equity to fund the project, take some time to look at your home the way a potential buyer would. A fresh coat of paint and a good yard cleanup can do a lot to make your home more appealing. You don’t need to spend a fortune on upgrades, just try to tie up small loose ends so you can get the most out of your home.
Before you’re ready to approach your bank about funding your renovation, it’s a good idea to understand each borrowing option.
HELOCs are currently the most popular form of non-mortgage credit in Canada. They’re also the biggest contributor to personal debt loads in Canada. A HELOC is convenient and flexible, allowing you to borrow between 65 and 80 per cent of your equity. But where many people get into trouble is the repayment process.
As you pay down your mortgage (or the value of your home increases), your equity will increase — which gives you the option to continuously borrow against your home. Because your HELOC isn’t tied into your monthly mortgage payment, many Canadians get caught up in making interest-only payments without touching the principal.
Another drawback is that HELOC interest rates are variable which can cause real financial difficulties if interest rates rise again.
A second mortgage is one type of home equity loan. Instead of borrowing funds as you need them as you would with a HELOC, a second mortgage is a lump sum amount deposited directly to your bank account.
Just as the name implies, a second mortgage is an additional mortgage on your home. You can borrow up to 80 per cent of your home’s value, minus what is still owing on your first mortgage. You are then responsible for making two regular mortgage payments.
For example, if your home is worth $400,000 but you still owe $300,000 on your mortgage, your borrowing limit is $20,000. Here's how that calculation looks: your maximum loan amount is $400,000 x 80%, or $320,000. Now subtract what you still owe on your mortgage: $320,000 minus $300,000 equals $20,000. In this example, your second mortgage could be a maximum of $20,000.
The benefit of a second mortgage vs a HELOC is that you’re obligated to make regular monthly payments. Just like your mortgage or any other bank loan, your payments will chip away at the principal amount. Having a lump sum on hand is convenient when you’re ready to get your project started, but it’s important to track your spending. A renovation budget is key. It will ensure that you’re aren’t spending your home equity loan on costs or expenses for which it wasn’t intended.
Like a second mortgage, these options let you borrow up to 80 per cent of your home’s value minus what you still owe on your home.
Whichever method you choose, your loan amount will be added to your mortgage balance. You may or may not end up with a lower interest rate on your mortgage, but your monthly mortgage payment will increase to accommodate your equity loan.
Remember that each option detailed above will involve extra fees such as a home appraisal, title search, insurance and legal fees, so make sure you’ve prepared yourself for those costs.
Just because you can borrow up to 80 per cent of your home’s equity doesn’t mean you should. Stick to your budget and borrow what you can afford to pay back.
Are you thinking of using home equity to complete some summer projects? Take the time to weigh your options and consider your existing debt load before you move forward.
Has home equity debt overwhelmed your finances? A Licensed Insolvency Trustee can help you explore your debt relief options. Book a free consultation today.
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