Unlocking Home Equity: Borrowing Against Your Mortgage

Borrowing against your mortgage, also known as a home equity loan, allows you to borrow money using your home as collateral. The amount you can borrow is based on the equity in your home, and you can use the funds for any purpose. This option is ideal if you have a specific large expense or debt to pay off, such as remodelling or paying for higher education. Home equity loans come with a fixed interest rate, which is higher than that of a first mortgage but lower than that of credit cards and other consumer loans. To get a home equity loan, you will need to submit an application and financial documents, and your lender will check your credit, just like with your initial mortgage.

Borrowing Against Your Mortgage

Home equity loans

A home equity loan is a consumer loan that allows homeowners to borrow against the equity in their homes. It is also known as a second mortgage, as the equity in the home serves as collateral for the lender. The amount that a homeowner is allowed to borrow is based on the difference between the home's current market value and the homeowner's mortgage balance due.

When considering a home equity loan, it is important to ensure that you can afford the additional monthly payments on top of your current mortgage and other expenses. Additionally, shopping around for quotes from multiple lenders can help you find the best rates and terms for your loan. It is also advisable to review your credit reports and improve your debt-to-income ratio before applying for a home equity loan, as these factors can impact the rates and terms offered by lenders.

HELOCs

A home equity line of credit, or HELOC, is a line of credit secured by your home. It gives you a revolving credit line to use for large expenses or to consolidate higher-interest-rate debt on other loans. HELOCs usually have a variable interest rate, which can change from month to month, calculated from an index and a margin. The index is typically the US Prime Rate, and the margin is constant throughout the life of the line of credit.

With a HELOC, you are borrowing against the available equity in your home, which is the value of your home minus the amount you owe on your mortgage. The amount you can borrow is based on the value of your home, your income, and the loan-to-value (LTV) ratio, which is typically 80-85% of your home's appraised value. For example, if your home is valued at $200,000, and you owe $120,000, the maximum HELOC you could receive is $50,000.

During the draw period, which typically lasts 10-15 years, you can borrow as much as you want up to your credit limit. You will receive monthly bills with minimum payments that include principal and interest. You can make additional principal payments to save on interest and reduce your overall debt more quickly. After the draw period ends, the repayment period begins, which can last anywhere from 10 to 20 years.

Cash-out refinance

Cash-out refinancing is a type of mortgage refinancing that allows you to borrow against your home equity. It involves taking out a new, larger mortgage that pays off your existing mortgage and gives you the difference in cash. This cash can be used for various purposes, such as home improvements, debt consolidation, college tuition, or a down payment on a second home.

To be eligible for a cash-out refinance, you typically need to have at least 20% equity in your home. The amount of cash you can access will depend on your home equity and the lender's maximum loan-to-value (LTV) ratio, which is usually 80% of your home's value. For example, if your home is worth $300,000 and you have $100,000 remaining on your loan, you have $200,000 in home equity. Multiplying the home value by the LTV ratio gives a maximum loan amount of $240,000, meaning you could borrow up to $140,000 in this scenario.

It is important to note that cash-out refinancing incurs closing costs similar to your original mortgage, typically ranging from 2% to 6% of the loan amount. Additionally, you will be repaying a larger loan with different terms, including a new mortgage rate, so it is crucial to carefully consider the pros and cons before proceeding.

Compared to a home equity line of credit (HELOC), cash-out refinancing may offer a lower interest rate on your main mortgage and a shorter repayment term. However, HELOCs usually have little to no closing costs, whereas cash-out refinancing has comparable closing costs to a first mortgage.

When considering cash-out refinancing, it is recommended to shop around for rates from multiple lenders to ensure you get the best deal. You should also weigh your alternatives, calculate your new monthly mortgage payments, and determine if the new loan is affordable for you.

Reverse mortgage

A reverse mortgage is a type of home loan that allows older homeowners to borrow money based on the equity in their home. The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), a federally insured program. To qualify for an HECM, you must be 62 years old or older.

With a reverse mortgage, the amount of money you can borrow is based on the equity you have in your home. The loan is typically repaid when the borrower no longer lives in the home, and interest and fees are added to the loan balance each month. The loan can be paid in a lump sum, as a regular monthly income, or at specific times and in specific amounts.

A reverse mortgage can be a useful option for older homeowners who need access to cash without having to sell their homes. However, it is important to consider the potential risks, such as increased debt and decreased equity. It is also important to shop around and ask questions before deciding if a reverse mortgage is the right choice for you.

In the US, the federal government requires you to see a federally-approved reverse mortgage counsellor as part of getting an HECM reverse mortgage. This can be a useful way to get advice and information about the process and potential risks.

Credit score requirements

While there is no universal credit score needed to get a mortgage, your credit score is a key factor in the mortgage process. It provides a snapshot of how good you are at managing your finances and how reliable you are at borrowing money. The higher your credit score, the more likely you are to find a mortgage lender.

Mortgage lenders will consider other factors when assessing your application, including your income, employment history, and debt-to-income ratio. They will also use a calculation known as a loan-to-value ratio (LTV), which looks at how much you want to borrow relative to the value of the home. A larger deposit can help with your application as it lessens the lender's risk.

Before applying for a mortgage, it is recommended that you obtain your credit score from banks, credit card companies, or online sources. You can then take steps to improve your credit score, such as making all your credit card payments on time, reducing any existing debts, and resolving any civil disputes.

In the US, conventional mortgages typically have higher minimum credit score requirements of 620, while government-backed mortgages like FHA and VA loans have more flexible credit score minimums of 500.

Frequently asked questions