Is using home equity to buy another home in Canada Legal? The answer is yes – Home equity is one of the most convenient ways to invest in another home purchase. So, you don’t have to worry about anything if you’ve accumulated enough equity in your home.
In this guide, we’ll show you how to leverage your existing home’s equity to invest in another property. You’ll also get to learn the complexities involved in the procedure. Keep reading to learn more about using lines of credit for down payments in Canada.
Using Home Equity for Down Payment on Second Home
If you don’t have enough cash for a down payment of another investment property, you can consider a home equity line of credit (HELOC) in Canada. It’s the best way to invest in a property that guarantees returns higher than the borrowing costs.
So, what’s a home equity line of credit? As the name suggests, a HELOC is a line of credit secured by an existing property’s equity. In other words, your home equity acts as collateral. Notably, that makes it even easier to get lower interest rates.
How a Home Equity Line of Credit (HELOC) Works
Most Canadian lenders issue HELOCs against 65 percent of a home’s appraisal value. However, when combined with amortized mortgages, one can push the limit to 80 percent. So, you need a minimum of 20 percent home equity to qualify for a HELOC.
After taking out a home equity line of credit, you’ll have to make payments each month. Since the financial plan depends on interest rates, the payment amounts can fluctuate depending on the current interest rate. The rates are tied to the prime lending rates.
The good news is that home equity lines of credit rates are usually lower than the rates of unsecured lines of credit. But since they are variable, they can increase when the prime lending rates rise, and vice versa.
For that reason, you must ensure you have enough cash at hand to fulfill the minimum payments at all times. Thankfully, you can lock your home equity line of credit rates for consistency. Most lenders provide that option.
Although there is a risk of change in interest rates, the impacts are minimal. Let’s say you take out a line of credit worth $10,000 from a Canadian Bank, and the rate rises by 0.25 percent. In that case, your payment can go up by about $20, which is low.
However, if you took out several HELOCs on several properties, the impact can be great when the interest rates increase simultaneously. And if you miss payments on a HELOC, it can hurt your credit score significantly.
How HELOCs Differ from Conventional Mortgages
Home equity lines of credit are different from traditional mortgages in terms of interest rates, payment terms, and borrowings.
When it comes to interest rates, mortgages feature both fixed and variable rates. While with HELOCs, the interest rates fluctuate. Both HELOCs and variable-rate mortgages change depending on the prime lending rates, and they carry similar risks.
When it comes to borrowing, you’ll get a full amount of money for a traditional mortgage. So, you cannot make more withdrawals upon receiving funds. While with a home equity line of credit, you can withdraw funds as many times as possible, up to the HELOC limit.
Another difference is on the payment terms. For mortgages, you’ll get a set payment every month based on principal and interest rates. However, HELOCs are only based on interest rates, which can fluctuate (as mentioned above).
Types of HELOCs in Canada: Definite vs. Indefinite
A home equity line of credit can be definite or indefinite, depending on the period of payment. Notably, a HELOC with a fixed term specifies when a client has to pay off the entire loan. The line of credit can mature after 5-25 years, depending on the lender.
But before the HELOC matures, you can withdraw up to the line of credit’s limit and only pay off the interests. And if you pay down the entire HELOC before it matures, you can withdraw more funds again. The time before the maturity date is the draw period.
Another type of HELOC is the one with an indefinite term. This home equity line of credit has no maturity date like its counterpart. Notably, many lending companies in Canada offer home equity lines of credit with indefinite terms.
With the indefinite home equity line of credit, you can borrow money, pay it down, and continuously borrow. Thankfully, you are only required to pay off the interests.
Advantages of Using Equity to Buy Investment Property Canada
Using home equity lines of credits to buy another home in Canada comes with several benefits. Here are some advantages of investing in a new property using a HELOC.
1. Safeguards Other Investment Portfolios
If you’ve accumulated enough equity in your existing home, you don’t need to tap into other investment portfolios to source funds to buy another home. Instead, you can take advantage of your home equity by applying for a home equity line of credit.
Withdrawing money from other investment portfolios can reduce your long-term savings significantly. Also, if the property you’ve purchased fails to pay itself, you’ll run the risk of losing the potential earnings in the detracted investment portfolios.
By using home equity to buy another home in Canada, you will enjoy discounted rates as the assets in other investment portfolios continue to appreciate. Not to mention, the HELOC rates are usually lower than the interest rates for personal loans.
2. Comes with Lower Fees and Closing Costs
Canadian lenders usually spend less effort and time to originate home equity lines of credit than first mortgages. So, that attributes to their lower fees and closing costs. Not to mention, the low-interest rates also make HELOCs more cost-effective.
When buying the second home, you can also negotiate on favorable purchase terms by financing it using home equity. The seller will view the home equity as a cash offer and appreciate that you’re not obliged to finance the purchase using a mortgage.
Thankfully, most lending companies in Canada usually cover part of the closing costs for home purchases involving home equity lines of credit. That can help you save hundreds or even thousands of dollars on the second home purchase.
3. Improves Cash Flow
By tapping into your accumulated home equity, you can get funds to invest in income-generating properties to improve your cash flow. On that note, you can consider Smith Maneuver rental property. Such investments will improve your net profit significantly.
Using home equity for a down payment on a second home will increase your cash flow if you rent it out. Since most Canadian lenders offer indefinite HELOCs, you can lower your monthly payments to maximize your rental income profits.
The cheapest and most convenient way to buy a new home is by tapping into an existing home’s equity. With strong home equity, you can rest assured that you’ll find the lowest interest rates from prospective lenders. The good news is, using home equity to buy another home in Canada comes with numerous benefits, including flexibility.