Using Your Mortgage Loan to Plan For the Future
Table of Contents
How to Build & Make the Most of Your Home Equity as an Investment for Your Goals
Home equity and a good mortgage can actually help you plan for the future. In fact, paying down your mortgage and boosting your home’s value helps to build equity to support future plans and goals.
Whether you want to invest in your existing property, a new income property, education, or retirement, you can do so with enough home equity.
Here’s a look at how home equity works, and how you can make the most of your home equity to invest and plan for the future.
How Can A Mortgage Help You Save?
Understanding Good Debt and Bad Debt
The wealthy stay rich because they look for opportunities to increase good debt and get rid of bad debt. Good debt is debt used to invest in something that appreciates in value and helps you save money or earn money. For example, a mortgage is considered good debt because it is going toward a house that will likely appreciate in value over time. Have I ever mentioned the franchise name of our brokerage is Smart Debt Mortgages? There’s a reason for that.
Bad debt is debt spent on something that depreciates in value, and won’t provide any return on investment. An example of bad debt is buying an expensive water vehicle, like a Sea-Doo that you end up using only a few times.
Should You Save First or Pay off Your Mortgage?
When you pay off your mortgage, you can have:
- Tax-free savings
- A guaranteed return on your investment—making it a risk-free investment
- Large cash flow and no debt during retirement
- No temptation to withdraw funds from a TFSA or RRSP
- Home equity
How to Build Home Equity
Home equity is the difference between your home’s value and the unpaid amount owing on your mortgage. For example, if your home is worth $300,000 and you owe $140,000 on your mortgage, then you have $160,000 in home equity.
You can build up your home equity by paying down your mortgage and increasing the value of your home.
Start With a Bigger Mortgage Down Payment
The best and simplest way to start building home equity is by making a large down payment when you first buy your home. Say you pay 20% of the purchase price as a down payment, then you’ve already built 20% home equity.
Make Mortgage Payments on Time
Pay your mortgage on time each month so you can pay down the mortgage principal. Late payments will slow down the process of paying off your mortgage and building home equity.
Increase Mortgage Payments, if Possible
The larger your monthly mortgage payments, the faster you’ll pay off the principal mortgage amount owing while building your home equity.
You can do this by shortening your mortgage term. You can also choose to pay your mortgage bi-weekly instead of monthly. Both of these options can have lower interest rates, allowing more of your payments to go toward paying off the principal amount owing.
Invest in Home Maintenance
Renovating, repairing, upgrading, and taking good care of your home will add to your home’s market value, which, in turn, will increase your home equity.
With each improvement you make to your home, your home value will go up alongside your equity. And if you stay on top of regular home maintenance, this will help keep your home value up as well.
Understanding Home Equity
Take Out a Home Equity Line of Credit
Interest rates can be much lower on loans secured by your home equity compared to other types of loans.
How Can Home Equity Help You?
Fund Renovations
Funding renovations is one of the most common reasons for taking out a home equity line of credit. Renovations are expensive, and it can take a long time to save up enough money to pay for home renovations.
But with a home equity line of credit (HELOC), you can invest in your home, making it more functional, comfortable, energy-efficient, and aesthetically pleasing. And you will also be increasing your home’s value, and in turn, building your home equity.
Fund Education
Paying for education to advance your career opportunities and earn a higher income is a smart way to invest your money, especially if you don’t qualify for student loans.
Some people also choose to fund their children’s post-secondary education with their home equity. But this is a risky decision since it likely won’t provide a return on your investment—unless your kids become high earners and pay off your mortgage for you!
Pay Off Debt
Paying off high-interest debt with home equity such as a HELOC that has a much lower interest rate can help you save thousands of dollars in interest over time. It will also decrease your monthly payments.
But this debt consolidation is only recommended if you have a financial plan and budget to avoid building up high-interest debt again.
Purchase a Second Home
Many homeowners will use the equity in their homes to purchase an investment property.
With enough equity to buy a second home and cover the costs of renovations, you can increase the value of this property and rent it out to earn extra income and pay down the mortgage faster.
Home Equity Lines of Credit Vs. Second Mortgages: What’s the Difference?
Home equity lines of credit (HELOC) and second mortgages are both home equity loans that use your home’s appraised value. And both options may have administrative fees, such as:
- Appraisal fees
- Legal fees
- Title search
- Title insurance
However, they differ in the following ways:
HELOC
A home equity line of credit (HELOC) is a revolving line of credit secured with your home. You can borrow 65% to 80% of your home’s appraised value, with often low and variable interest rates that change as market interest rates rise and fall. And you only pay interest on the amount you use.
So, say your home’s appraised value is $300,000, you can have a credit limit between $195,000 and $240,000.
You can access the money as needed, at any time, up to the credit limit. And you can pay it back and borrow it again, much like a regular line of credit. In most cases, the minimum monthly payment is the accrued interest.
To qualify for a HELOC, you will need to have good credit and a stable income.
Second Mortgages
A second mortgage is a second loan that you borrow on your home. In many cases, you can borrow up to 85% of your home’s appraised value, minus the balance owing on your initial mortgage.
So, using the example from before, if your appraised home value is $300,000, then 85% of your home value is $255,000. Subtract $150,000 (the amount owing on your mortgage), and you will be eligible to borrow up to $90,000.
The borrowed amount of your second mortgage will be deposited into your bank account in one lump sum payment or you will pick up the cheque from your lawyer’s office.
This loan is secured with your home equity. You have to pay off your first mortgage while you simultaneously pay off your second mortgage. This means you have two monthly mortgage payments.
Since second mortgages are viewed as riskier for lenders, interest rates tend to be higher on second mortgages. And for the most part, they are at fixed rates. Lending requirements can be more lenient, so those with lower income and credit scores may qualify.
To find out which home equity loan is right for you, speak with your mortgage broker. Your broker can help you make the most of your home equity so you can reach your financial goals in life.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.