Part of the challenge in the local real estate market is a lack of supply. As in, there aren’t enough homes available to meet the buyers demand. But the other less discussed part: homeowners are using their home equity line of credit to purchase additional properties.
With housing prices reaching new record highs, homeowners have started to approach banks to “unlock” some of that equity. It’s likely a key reason why cottage country has become so expensive.
A home equity line of credit (also referred to as a HELOC) allows the owner to access the equity in their home. In the simplest terms: this is the difference between your home’s value and your mortgage balance.
As an example:
Let’s say your home is appraised at $1,000,000 and you approach your bank to apply for a home equity line of credit. Banks will generally lend you up to 80% of the appraised value ($800,000 in this case) in a line of credit, minus the value of your mortgage.
So, if you have a $1,000,000 home, your lender will lend you $800,000. If your mortgage is $200,000, you now have access to $600,000!
Since HELOC’s are secured against the equity value of your home, home equity loans offer extremely competitive interest rates. These are usually close to that of mortgage rates. Compared with unsecured borrowing sources, such as credit cards, you’ll be paying less interest for the same loan amount.
HELOC’s sound great, right?
Well, they can be if used properly! HELOC’s can help you unlock equity from your home and build further equity if used to make strategic financial investments, like a student rental property.
Let’s say that you used the $600,000 in home equity line of credit to buy a rental property. Since you’re required to put 20% down on rental properties, you could use some of the $600,000 to fund that (talk to your banks about specifics as each scenario is different).
Now, you have your primary residence and a secondary property. If that secondary property produces positive cashflow, even better! Now you are using your own equity in your primary residence to earn further income and equity in a secondary property.
It may even possible to buy a 3rd property or a cottage with some of the remaining equity.
The most basic calculation on borrowing from your HELOC is: any money you borrow from it should have a greater return that the cost to borrow it. As an example, if your HELOC interest rate is 3%, you should use it if you can guarantee at least a 4% return elsewhere. The difference between the two is called arbitrage.
There is some risk with a home equity line of credit
Like any investment, there is a level of risk with a home equity line of credit.
The most important thing to remember is that this is not “free money”. Anything borrowed on this line of credit is simply further debt. Consider it like a credit card, but at a much lower interest rate.
If you borrow from your HELOC at 3% to put it in the stock market, that money could return 10, 20, 30, or 50% returns! But it could decline at the same levels, putting you into further debt.
Keep in mind that lenders consider an available balance on a HELOC to almost BE your mortgage. They know that you have access to those funds at any time and could use them, so it can be a liability to a bank if you’re trying to get additional loans or credit cards.
Other considerations for a home equity line of credit
Home equity lines of credit are a revolving source of funds, much like a credit card, that you can access as you choose. This can be helpful, especially in today’s climate.
If you’ve lost your job because of COVID-19 and need cash, taking out a HELOC may be a good option. It can get you through the tough times at a low interest rate.
If you’re considering buying a rental property in Guelph, get in touch with Beth and Ryan. They can provide recommendations on Guelph mortgage brokers and Guelph banks to talk to about unlocking equity. And, help you find a suitable property to meet your financial goals!
Beth and Ryan Waller are Realtors with Home Group Realty.