How much equity can I use to buy a second home?

by Emma Scott on 29 Jun 2021

More Canadians are choosing to invest their money in real estate and purchase a vacation home, cottage or rental unit. While buying a second property is a big investment that can help grow your wealth, it is important to ensure that you can afford it first. Tapping into your home equity can help make buying a second home easier for many Canadians. In this article, we will cover what home equity is, how much of it you can use, and how you can use home equity to take out a second mortgage.

What is home equity?

Home equity is the value of a homeowner's interest in their home. When a buyer takes out a mortgage loan from a financial institution to pay off their home, they and their lender both have vested interest in the property.

Typically, lenders have the primary interest in a home after it is first bought. This is because they have lent the majority of the funds needed to pay for the house whereas the buyers have paid their down payment. With each mortgage payment, homeowners gain interest in their homes while their lender loses theirs.

For example, buyers may purchase a house for $550,000, put a 5% down payment on it, and then use the funds from their lenders to afford the rest. This means that the owners have secured $27,500 of their home at the time of purchase. As years pass and they make mortgage payments, they have paid off $127,500 of their mortgage, leaving them with an outstanding total of $422,500. While the owner once had $27,500 of interest in their home and the bank had $472,500, they now have $127,500 and the bank has $422,500.

The amount that a homeowner has paid off their home loan is their equity.

Financing options for buying a second property

There are many ways that homeowners can tap into their home equity to buy a second property. Home equity loans, home equity lines of credit, and reserve mortgages can help potential investors leverage their primary residence to get the cash they need to start investing in real estate.

Home equity line of credit

A home equity line of credit (HELOC) is a credit line that homeowners can access by leveraging their home equity. In Canada, owners are restricted to borrowing up to 65% of the appraised value of their house.

To determine how much your HELOC is, take the value of your home and multiply it by 80%. Subtract the outstanding balance of your mortgage loan. The final figure will be how much equity they have at their disposal - as long as it is not over 65% of the current market value of the property. To be sure, just divide the HELOC by the property's current market value.

Home equity lines of credit can help homeowners secure a down payment for a rental or vacation property

While home equity lines of credit are useful ways to finance buying a second property, there are some limitations to them. Homeowners can only access a HELOC when they have built up at least 20% equity in their home. They will also need to have good credit to use money from their HELOC. These regulations are to help protect a lender and ensure that those borrowing from their home equity can still make their loan payments.

If you meet the criteria to access your HELOC, there are many benefits to using it to fund buying a second property. First, the more you pay back your mortgage loans, the more you could borrow. A HELOC is also a revolving line of credit similar to a credit card or other credit line. This means that homeowners can access the money at any time, but do not have to make a loan payment until they actually spend it. This can be helpful for those who need help securing a down payment for a rental or vacation property.

Buy an investment property with a home equity loan

A home equity loan, also known as a second mortgage, is much similar to a HELOC. This type of loan allows homeowners to borrow up to 80% of the appraised market value of their primary home, minus the balance due on the mortgage. Home equity loans are also based on the homeowner's credit score and payment history.

The primary difference between a second mortgage and a HELOC is that second mortgages act like a typical mortgage - hence their name. Second mortgages usually have fixed rates and come as a lump sum of cash that a person needs to pay back. Other administrative fees like an appraisal, title insurance and such will also be added to their rates. The repayment schedule is fixed and it will need to be paid off by the time the period is up.

A home equity loan is a useful way to get the cash you need to invest in real estate

Using your home equity to get a lump sum of cash can be helpful for investing in a second property, but there are some downsides to this route. For instance, homeowners will need to cover the costs of both their first mortgage and their second mortgage at the same time. Both loans may put a strain on one's income and could reduce cash flow and, sadly, there is little assistance. A home equity loan is not tax-deductible unless used for renovations.

Homeowners will also face a higher interest rate on their second mortgage than their primary home mortgage. This is because having two mortgage loans is riskier for both the borrowers and the lenders.

Use a reverse mortgage for your second property

A reverse mortgage, sometimes called an equity release, is a loan that allows you to get money from your home equity without having to sell your property. Homeowners can get up to 55% of the appraised value of their property from a reverse mortgage, making it easier to buy other properties.

In order to qualify for a reverse mortgage, you must be at least 55 years old and a homeowner.

Reverse mortgages do not need to be paid back until the homeowner decides to buy another primary residence, moves out, or passes away. They also don't owe tax on the money borrowed. This makes this a great option for older individuals on a fixed income because they can delay loan payments.

The only issue is that reverse mortgages have higher interest rates than those on a first mortgage, and interest will accumulate from the moment the loan starts. There is also the possibility that you may lose equity in your home over time.

Leverage your home equity to receive a second mortgage or reserve mortgage to help buy a second property

Refinance your primary property

Home equity is a source of funds that can help finance a real estate investment, but they still may fall short. Refinancing a house is a possible solution. While a property's appreciation can fluctuate based on the current market, its mortgage doesn't reflect that. Refinancing a home will cause its mortgage terms to update according to its current worth on the market. This may result in the owners having more equity, lower interest rates, and an easier time financing their real estate investment.

Before you refinance your property, take the time to consider whether it is worth it. Refinancing can get you a lower interest rate and more equity, but this isn't guaranteed. There is always a risk that your new rates may be higher than what you would like.

Buy a second investment property with equity

Real estate is a valuable investment in Canada. Currently, properties are gaining appreciation much faster than ever before. Interest rates are also low, making it easier for people to purchase a new house and take on a new mortgage. Whether you are considering buying a second home to be used as a rental property or a family cottage, now is a good time to invest.

Before you start house hunting, take your time to do some research. Each equity option has a different percentage of how much you can receive. HELOCs have 65%, loans 80% and reverse mortgages 55%.

Determine what equity option is the best for financing your investment and figure out whether you should refinance your property. It is important to think about your financial situation, the expected costs, interest rates, and more for both your properties.

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