I work with many clients who already own a home and want to access some of the equity in their home. There are many different reasons clients may have to get equity out. Here are a couple of reasons...
- get equity to purchase another home
- get equity to purchase a vacation home
- pay off debt and reduce monthly costs
- purchase a vehicle or RV
- purchase an investment
As a home owner you can borrow up to 80% of your home's value with a traditional lender like a bank, trust company or credit union. It is also possible to arrange financing up to 90% of your home's value with a private lender or alternate lender.
Calculate how much you can borrow
When you apply to get more money from your home, a lender would generally call this a refinance. You are refinancing your home to get more equity out.
Your home is worth $400,000 and you want to borrow up to 80%, you could then borrow $320,000. If you have no mortgage, then you could borrow the full amount and you would receive $320,000.
If you have a mortgage on your home already in the amount of $250,000, then you would receive 80% of your home's value less the current balance, therefore you could borrow $70,000 from your home.
Let's look at another example. Your home is worth $400,000, you have a mortgage of $300,000. How much can you borrow?
With a traditional bank, trust company, credit union, you can arrange financing up to 80% of the home's value less any outstanding mortgage. In this case, you would finance $320,000 less $300,000 which would result in you receiving $20,000.
If you chose to work with a private lender, or alternate lender, you could finance up to 90% of your home's value less the current mortgage. With a private lender, you could therefore borrow up to $360,000 minus $300,000 or $60,000.
Depending on your situation and circumstances, you may want to borrow with a traditional lender or you my wish to choose a private lender.
Why is there a difference in amount I can borrow between lenders?
When you borrow from a traditional lender like a bank or some trust companies or credit unions, they are legislated by the government. The charter and rules that these institutions lend under don't allow them to finance more than 80% of the value of a home without mortgage insurance or default mortgage insurance.
Mortgage insurance, also know as high ratio mortgage insurance or default insurance, is provided by 3 companies in Canada, CMHC Genworth and Canadian Guarantee and provide the lender insurance in the case of borrower mortgage default. Federally legislated financial institutions are restricted from lending more than 80% of the value of a residential property unless they insure the loan against default with a mortgage insurer.OSFI, Office of the Superintendent of Financial Institutions
In June 2012, the government made changes to mortgage rules reducing the maximum default-insurance for mortgage refinance to 80% of the value. This effectively placed a cap on the maximum a traditional lender could provide a homeowner when applying to refinance their home.
As a side note, in November 2016 the Government's Department of Finance eliminated default insurance for borrowers taking equity out of their homes. They also eliminated default insurance for homes valued over $1 million, for borrowers with credit scores under 600 and for mortgages to purchase investment properties.
The elimination of default insurance for mortgages listed above, including mortgage refinances, resulted in higher interest rates for borrowers applying for these types of mortgages.
Private lenders and alternate lender are not governed under these same rules because they don't apply for default insurance on their mortgages. These lenders take more risk and charge higher interest rates to borrowers.
What's the difference when I borrow from a traditional lender versus a private lender?
The two main differences between a traditional lender and a private lender is the amount you can borrow and the interest rates that they charge.
Let's use the example from above. Your home is worth $400,000, you have a mortgage of $250,000 and want to access $70,000. You have several options to get this money. Some are better than others depending on your situation and your current mortgage penalty, rate, etc.
Your current lender could offer some of these options. Some options will be available through a different lender and some would be available through an alternate lender or a private lender. To get a full picture of your own situation, you should consult a mortgage broker who would have access to all your options, not just a limited selection.
Option 1: Refinance your home, payout the existing mortgage and set up a new mortgage.
In this case, you could either work with your current mortgage lender, work with a mortgage broker who would offer access to many different lenders. Your current mortgage would be paid out. There could be a penalty. You would receive the $70,000 cash less any penalty, legal fees and closing costs. You would have a new mortgage which could be amortized up to 30 years. One payment would be coming from your bank account to pay for the mortgage.
The advantage to this option is that your final mortgage payment is usually close to your original payments. You only have 1 payment and you will qualify for best refinance rates. (note, these rates aren't always the same as best purchase rates because of government changes described earlier)
The fees and costs to set up this mortgage could include:
- first mortgage payout penalty
- legal fees
- title fees
- appraisal fees
Option 2: Refinance your home, keep the existing mortgage and set up a Home Equity Line of Credit.
In this case, you would keep the existing mortgage and payments that you are currently making. You could work with your current lender or with another lender. The lender would arrange a home equity line of credit for $70,000 (80% of the home value less your current mortgage balance).
There would be no penalty on your existing mortgage because you haven't paid it out. You would have 2 payments, one for the current mortgage and then a second payment for the line of credit balance.
These lines of credit are typically set up as an open term with an interest only payment. The rate is usually prime plus 0.50% but some lenders charge more. The line of credit will allow you to use some or all of the money and you can pay back all or a portion without penalty.
The advantage to the line of credit is that you don't have to pay a penalty on the first mortgage. You can pay interest only payments. The amount your borrow is flexible. You don't have to use all the money at once, that is, you can draw some out then more later.
The disadvantage is that you would have 2 payments instead of one. Home equity lines of credit have more strict requirements and are therefore a little more difficult to qualify for. The home equity line of credit is registered with a collateral charge.
If you have an existing mortgage that was set up by a lender that registers collateral charges, then it's more difficult to work with a different lender for this line of credit option. When lenders register mortgage with a collateral charge they are effectively locking you into working with them only.
The fees and costs to set up this home equity line of credit could include:
- legal fees
- title fees
- appraisal fees
Option 3: Refinance your home, keep the existing mortgage and set up a second mortgage.
In this case, you would keep your existing mortgage and set up a second mortgage. You could work with your current lender or another traditional lender.
If you had a traditional mortgage and qualified for a line of credit, then the line of credit is the best option. Your traditional lender would also offer a second mortgage but the rates would be higher than those available with a line of credit.
Your traditional lender will only finance up to 80% of the value. With this option, most borrowers will go with the private (non-traditional, alternate) lender because they will have access to 85% or 90% of the home value.
The main advantage to setting up a second mortgage with a private lender is the speed. You will receive your money fast, typically within a week.
Another advantage is that you can qualify with good or bad credit. Your rate is generally influenced by your credit score. With bad credit, you will pay more.
Income confirmation is also more flexible. Alternate lenders (private lenders) will not require the same documents as bank and traditional lenders will. It's always important ensure that you can afford the payments, but alt-lenders will include sources of income that banks can not include.
The main disadvantage is that your costs and fees can be high.
When I review options with clients, a private second mortgage is generally an interim solution. You need money fast then we have a plan to pay this out with another solution that is much less expensive.
Self employed clients with CRA debt have trouble qualifying for traditional financing. A private second mortgage to pay off the debt in the short term is a good interim solution. Once all the CRA debt is paid off, then we can generally get traditional financing at lower interest rates.
The fees and costs to set up a second mortgage could include:
- legal fees
- appraisal fees
- lender fees (could range from 0% to 5%)
- broker fees (could range from 2% to 5%)
Why would I choose to borrow with a private lender?
There are a couple of reasons you would choose a private lender:
- Your credit score isn't above 600
- you need to borrow more than 80% of the value of your home
- there is a large penalty to pay out your current first mortgage
- you need money quicker (under a week) compared to a traditional lender would process your request
- you don't qualify for financing with a traditional lender
- you're self-employed and owe money to CRA
When you want to borrow against your home, the best and cheapest options would be to arrange financing with a traditional lender. The interest rates and costs are lowest with this options. However, sometimes that isn't an option and getting this financing will help you to get back on track.
I suggest that your best starting point is to work with a mortgage broker who has access to all the options so that you can make an informed choice.
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