As a professional mortgage agent serving the Greater Toronto Area, it’s a question I get asked all the time, what is the best way to build equity?
Most of us already know that our home’s equity is the amount of our home which we own minus the outstanding balance and interest on our mortgages. However, traditionally people often appreciate there as being only three ways to actually build equity. First off, we pay our mortgage each month. With every mortgage payment we then own a little more of our home and add a little more to our home’s equity. Alternatively, we attempt to add equity to our home by increasing our home’s market value through physical alterations and renovations. This and by hoping that our home will appreciate in value as consequence of favorable market conditions.
However, as well as physical alterations and paying off as much of our mortgages as quickly as possible, there is fourth way to build equity. In fact, if you’re serious about building equity, you perhaps shouldn’t be thinking about taking out a mortgage on a property at all. Instead, you should perhaps be thinking about taking out a Home Equity Line of Credit, or as it is popularly abbreviated, a HELOC.
What? What’s a HELOC?
Okay, it sounds new, a little bit intimidating and if there really was a viable way to build equity quicker than by attacking your mortgage with everything you’ve got, surely somebody would have told you about it by now? Wouldn’t they?
Well, actually no. You see, HELOCs have actually been around a long time. One of the key differences between a HELOC and a traditional mortgage, however, is that mortgage brokers get paid a lot more money to sell mortgages than they do HELOCs. In fact, many banks don’t actually provide any incentives at all for brokers to sell HELOCs.
Why? Three words: No Compound Interest. With a Home Equity Line of Credit, you only pay interest on the remaining balance of your mortgage. This alone can save people thousands, if not tens of thousands in interest and significantly shorten the length of people’s overall borrowing terms.
Sound to good to be true? It gets better. With a HELOC there are no early repayment penalties and you can pay as much or as little as you want each month. In fact, with a Home Equity Line of Credit, you even have the option to just pay the minimum outstanding interest on your balance each month. Compare that alongside a traditional mortgage with compound interest, early payment penalties and penalties on even so much as paying too much of your mortgage off per annum, and the HELOC is a hands down winner when it comes to people really looking to build equity.
Okay, so what’s the catch? Well, there is one, but not really. Qualifying for a Home Equity Line of Credit is essentially just the same as qualifying for a traditional mortgage. However, with a HELOC people aren’t able to borrow more than 80% of their home’s appraised value. Likewise, HELOC interest rates are open and fluctuate with the prime, often making them a little higher than traditional mortgage interest rates. However, for people who feel like they want to run for cover at just the mention of variable interest rates, the HELOC has another bonus. – If you ever feel that the prime rate is going too high, you can lock in the rate and turn a HELOC into a traditional mortgage. And let’s just remember, if times ever look like they are not going in your financial favor, a traditional mortgage doesn’t let you decide how much or how little you can afford to pay each month now does it?
To HELOC or not to HELOC?
If you’re serious about building equity, a HELOC is definitely something which you should therefore be thinking about. Remember though, if you do decide that a HELOC might be in your best interests, your bank is likely the last place where you should head for impartial advice on actually getting one.
To your Wealth!