A growing number of homeowners are pulling cash out of their homes through equity loans. As you know real estate value increases with time and it’s a great idea to use your home equity for purposes like paying off a high-interest rate credit card debt or home renovation projects.

But what exactly is a home equity loan and how does it work?

Let this guide clarify your home equity concerns so you could get the most out of your home.

What is Home Equity?

Home equity is the homeowner’s interest in a home. In layman’s terms, it’s the portion of your property you truly own. Most of the time, when purchasing a home, you don’t usually pay the entire sum with cash. With a mortgage loan, you receive cash upfront then make payments over a set time period until the lender is paid back in full.

For example, when you first buy your home, your home’s equity is equal to the down payment you made. That‘s because that’s the only portion of your home you’ve actually paid, therefore you own.

As time passes by and you’re able to pay on your commitments, your home equity increases. You earn more equity with each loan payment. Regardless of the interest, any amount you’ve paid against the principal of the mortgage loan is your home equity–that‘s the portion you own. 

What is a Home Equity Loan?

A home equity loan or a second mortgage allows homeowners to borrow money against their equity.

You can borrow through a bank or lender the amount of your home equity. Once your loan is approved, you will then receive the money in a single lump-sum payment.

Upon agreement, you will pay the loan back with interest over a set time. Your monthly repayment will depend on the interest rate and the amount you’ve borrowed.

Using Home Equity

There are no rules on how you will use the money you’ve borrowed against your home equity. 

A home equity loan has longer borrowing periods with fixed interest rates, having a more structured payment plan. These are some good reasons why a home equity loan can be an affordable option:

  • Consolidate High-Interest Credit Cards. A home equity loan has a low-interest rate for a credit-worthy borrower. Using your home equity loan can help you pay off debt quicker by paying off a high-interest credit card with an interest rate of 15% or 20%.
  • Make Home Improvements. Major home renovations like bathroom or kitchen remodels can cost an arm and a leg. Borrowing money against your home equity and investing it back in a home renovation makes a lot of sense.
  • A Back-up Emergency Fund. Having a home equity loan as an addition to an emergency fund could be a lifesaver, just in case you’ve hit a large and unexpected expense. The great thing about it is that the money is there when you need it most, sort of like a lifeline.
  • Buy Your Next Home. The equity in your current home can be used as a down payment if you decide to buy a new home. Structured as a short term loan, securing the remaining equity in your old home and designed to be paid off with the proceeds from the sale of your old home.

How To Qualify For A Home Equity Loan?

To determine if you are eligible for a home equity loan, follow these steps:

  1. Find out your home’s worth. Oftentimes, your home’s market value will be different today than what you’ve paid for it. Before you apply for a home equity loan, you can improve your home’s worth by making smart and affordable renovations to your home.
  2. Calculate your home equity. The difference between the value of your home and the current outstanding mortgage debt is your home equity. Calculating it means figuring out what your home is worth and subtracting the existing liens on the property from that total.
  3. Provide income verification. Before you’re approved for a home equity loan, you will be required to provide income verification. The requirements will vary depending on how much equity you have and the amount of loan you are trying to secure.
  4. Check your credit score. You’ll need a credit score of at least 760 and a minimum of 620 to get the best rate on a home equity loan. So, if you score lower than that, chances are you won’t qualify for a loan at all.
  5. Review your credit history. Lenders will evaluate the types of credit accounts you’ve opened or closed in the past, your payment history and if you have any outstanding balances before approving your home equity loan. If you have a relatively high amount of credit left, you might not get the best rate even if you have an 800+ credit score.

Talk To A Trusted Mortgage Broker

If you are interested in a home equity loan, it’s best to plan carefully by talking to a mortgage broker and a financial advisor first. A good advisor helps you make financial decisions with confidence while benefiting from their years of experience.

what is home equity loan?, Mortgage Broker in Greater Toronto Area, Canada

Daisy Raouph, CLU, CHS, specializes in mortgage financing solutions and financial services. A Mortgage Broker and Financial Security Advisor with over 30 years of experience in financial services. Contact us today to review your mortgage financing options. We can help!