How Do I Know If Home Equity Debt is Right for My Reno?

Home renovation season is upon us once again. If you’ve been eyeing those home improvement flyers, you’re not alone. Although home reno spending was down in 2018, many homeowners continue to prefer to renovate rather than relocate. And a lot of Canadians choose home equity debt to fund their reno.

You may be intending to landscape your property, focus on repairs or go all-out on a remodel. Regardless of your renovation goals, it’s important to keep your spending in check and your debt load in mind.

3 things to do before you commit to a renovation (and home equity debt)

Before you get caught up in the “look” you’re going for in your home, first consider the cost. Here’s where to start:

  1. Speak to a few contractors in your area who can draw up a quote based on what you have in mind. Make sure you’re dealing with reputable companies who will work with you in terms of price, time-frame and will ensure your project is completed exactly how you want it. Start by checking reviews and asking for samples of past projects.
  2. Once you know the estimated cost of your project, you can draw up 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. And, as the pros suggest, add 20 per cent to that number, just to be safe! You’ll also need 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.
  3. If you’re planning to rely on home equity debt to complete your project, prepare your home for an appraisal. 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.

So, you ask: What’s the best way to use my home equity? Before you’re ready to approach your bank about funding your reno, it’s a good idea to understand each borrowing option.

Home Equity Line of Credit (HELOC)

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.

Second mortgage

A second mortgage is a home equity loan. Instead of borrowing funds as you need them as you would with a HELOC, a home equity loan 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.

Let’s look at an example. If your home is worth $400,000 but you still owe $300,000 on your mortgage, the maximum you could borrow would be $20,000. Here’s how that calculation looks:

 

Value of your home $400,000
Maximum loan amount ($400,000 x 80 per cent) $320,000
Minus balance still owing on your mortgage $300,000
Home equity loan credit limit   $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.

Other types of home equity loans

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.

  • You can choose to borrow by refinancing your home before your mortgage renewal date, which means you’re essentially breaking your mortgage agreement and you’ll be charged a prepayment penalty.
  • You can also wait until your mortgage is up for renewal to apply for a home equity loan.
  • Finally, your bank might offer you a blended rate — meaning the new (possibly higher) interest rate for your home equity loan will be blended with your mortgage interest rate.

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.

3 additional things to consider before borrowing against your home’s equity

  1. 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.
  2. Take some time to consider all your options before deciding. Be sure you’re able to carry the extra monthly costs and you’re able to repay your loan in a timely manner.
  3. Don’t borrow more than you need! 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 your home equity to complete some summer projects? Take the time to weigh your options and consider your existing debt load before you pull the trigger.

How will you finance your home renovation this summer? #LeaveDebtBehind #HomeImprovement #Budgeting