In today’s housing market, buying real estate is one of the best investments you can make — and contrary to popular belief, real estate investment is something even ordinary homeowners can get involved in.
Buying a second investment property and renting it out is a great way to generate a passive income, and the seed capital you need might be right under your feet in the form of home equity.
From consolidating debt to funding renovation projects, there are many reasons why people get home equity loans in Ontario — but did you know that a home equity loan or second mortgage can also be used to generate the money for a down payment on an investment property?
Using home equity to buy another home in Canada is an established process, and with housing prices in cities like Toronto rising 13.5% in 2020 alone, it can be a great way to take advantage of a market that stayed consistently hot for the past decade.
If you are interested in using equity to buy another house in Ontario, however, there are a few things you should know about the process. This blog will outline how your home equity can help you purchase an investment property, and will provide some tips for how to do so in a responsible way.
1. How Much Can I Borrow?
The first question most people who are considering using home equity to buy another home in Canada will need to answer is what is a home equity loan in the first place?
A home equity loan is a financial tool that allows you to take out a secured loan against the value of your house (you can learn more about the difference between second mortgage and home equity loan here). This means the amount you can borrow is determined by how much equity you currently have, which is calculated using the following formula:
X = Y – Q (where X is home equity, Y is market value of home, and Q is the amount remaining on your first mortgage).
Homeowners in Toronto have seen their home equity soar over the past few years as property values have risen, and if you bought a house for $500,000 in a good neighbourhood ten years ago, your current equity may be significantly higher than the total value of the home when you purchased it.
This means that if you want to buy an investment property, you have plenty of capital at your disposal: at Burke Financial, we offer up to 85% LTV, or loan-to-value — so if your home equity is estimated at $600,000, you can borrow $510,000, which can easily get you a down payment on a second house.
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2. How Do I Apply for a Home Equity Loan?
Home equity loans are offered by a variety of financial institutions, but in most cases they are used as a home improvement loan or to consolidate debt. If you are borrowing to purchase an investment property, you may face additional hurdles.
This is due to the fact that a home equity loan is a secondary loan to the original mortgage, meaning that should you default, your original mortgage lender will be paid first. This pushes the risk for the secondary lender higher, and can lead to the application being rejected, or to higher interest rates in the event that it is approved.
If you are considering using equity to buy investment property Canada, it is a good idea to work with a mortgage broker like Burke Financial rather than going directly to a bank.
A mortgage broker works on your behalf to secure the best possible deal, and while we do plenty of business with banks, we also work with other lenders who are willing to take on additional risk, or to extend loans to borrowers with credit scores below 650.
This means we can offer clients a greater range of borrowing options, and can process applications more quickly. If you need a home equity loan quickly in order to take advantage of a great deal on an investment property, a mortgage broker can provide much greater flexibility when it comes to unlocking the funds you need.
3. How Do I Avoid Becoming Over-Leveraged?
The biggest risk homeowners who are using home equity to buy another home in Canada face is becoming over-leveraged. Over-leveraging happens when you go into debt to purchase an asset that declines in value, leaving you on the hook for a mortgage, for example, that is worth more than the re-sale value of the home.
While Toronto’s housing market shows no signs of cooling down, let alone dropping, taking on significant amounts of debt in order to buy a second investment property before you have finished paying off the first always involves some degree of risk.
One of the most important things to consider, when dealing with home equity loans, is interest rates. Interest rates are currently at historic lows, but there are indications they may rise later this year. That means this is a good time to borrow, but you should do so with the awareness that when it comes time to refinance, you will likely end up paying a higher rate than you currently are.
If you have a good salary and a secure job and can afford to see a future increase in rates, then an investment could be a good idea. If a one or two percent increase would cause significant problems, it probably isn’t — especially given that the market might be slowing in the near future.
While using home equity to buy another home in Canada is not without its risks, there can also be significant rewards, so long as you approach any potential investment property prudently — and with an eye to long-term gain rather than short-term payoff.
If you’re interested in knowing more about using equity to buy another house through a home equity loan or second mortgage, get in touch with Burke Financial to explore your options today.