Home equity deserves at least as much, and arguably more, of a homeowner's attention than interior design or lawn care currently seem to receive. For too many reasons, home ownership can no longer be a passive role for Canadians. Those intent on preserving their investment while improving their financial position must become committed home equity managers.
Equity is the value that would remain in the property owner's hands, in a specific market, after deducting all debt, including mortgages, registered against the real estate. For instance, the home equity in a residential property valued at C$500,000, with mortgages totaling C$350,000, would be C$150,000. (In an actual sale to liquidate home equity, costs like real estate commission and lawyer's fees could reduce that C$150,000 by thousands, depending on the specifics.)
Successful management of home equity hinges on incorporating choice and flexibility into every possible aspect of ownership. This ensures alternatives will exist whatever the future holds. For instance, when arranging a mortgage, select options that match your income pattern and allow you to pay off the principal as quickly as possible. Avoid buying beyond your means and signing on for "house rich, cash poor" lifestyles that embroil you in long-term debt. Canada's new interest-only mortgage is an excellent example of how a mortgage can, on one hand, offer choice and flexibility essential to building home equity and, on the other hand, become a debt accelerator when used by those living beyond their means.
Reputable mortgage lenders and mortgage brokers are long-term thinkers. They want to be sure the short-term gain garnered by arranging a mortgage to purchase a property is not obliterated by long-term crushing debt. The mortgage industry, aware that consumers do not always seem to know what's in their own best interest, generally bases lending on an individual's proven ability to repay the debt over the years ahead, not just when they sign on.
"I wish [consumers] were all a little more far sighted," said Lee Goderstad, President of GMAC Residential Funding of Canada. "A mortgage broker generally is more interested in getting the deal done pain-free for everybody rather than earning a bit more commission. That [service] is more compelling."
Goderstad stressed that income and repayment capacity are important criteria in mortgage lending, even when lenders promote increased access to home equity. He emphasized that mortgage brokers in GMAC's Mortgage Intelligence network, do not want borrowers to take on more debt than they can comfortably repay and, therefore, qualification for repayment is an important step. In spite of this cautious approach, mortgage brokers use more flexible borrowing criteria than traditional banks and also shop the full market range of lenders (including banks) to get the best rates and terms for their client borrower.
Mortgage Intelligence 's new home equity line of credit, called i provideTM allows access to up to 90 per cent of home equity without any lender fees or mortgage insurance premiums. A line of credit is a mortgage loan which allows the borrower to withdraw funds up to a pre-set limit. Once in place, the line of credit allows the property owner to decide when, and if, to withdraw funds, and when and how to repay them. Interest-only payments are due on advanced funds only, not the full amount of the line of credit.
For instance, a C$250,000 traditional amortized mortgage with a 5-year term at a loan-to-value of 75 per cent, and an interest rate of 5.19 per cent, would require monthly payments of C$1481.17, representing principal and interest. The payment for a comparable i provideTM fully-withdrawn line of credit would be C$1234.65 of interest. There is a difference of $246.52 per month even though the interest-only rate carries a surcharge which brings the rate to 6 per cent. Remember, that although the original debt of C$250,000 does not increase over five years of interest payments, no progress has been made towards repaying the debt.
Payment flexibility allows a home buyer, or a home owner who is renewing, to decide to reduce the monthly mortgage payment at a time when the extra funds can be used elsewhere to greater financial advantage. They may be directed to an investment or to assist a child with tuition or other education costs. During the start up of a business venture, while returning to school or another income-building project, an interest-only mortgage can reduce monthly financial pressures. Homeowners with inconsistent or hard-to-predict earning cycles like writers, actors, contract workers and other self-employed professionals, may welcome the financial breathing space.
The absence of administration fees is another plus.
At the end of the 5-year interest-only term, the line of credit:
- may be repaid by shifting to payments of principal and interested based on the remaining life of the mortgage (amortization) of 20 years, or,
- may be renewed for an additional five-year interest-only term.
The ideal home equity management approach would involve using the less-demanding monthly payment to improve financial stability while aggressively paying off the principal. This way, at the end of the term, you'll be further ahead financially than if you selected a traditional repayment plan. The faster principal is repaid, the smaller the total amount of interest paid. Traditional 25-year amortized mortgages can cost at least twice what was originally borrowed. Play around with an online calculator that lets you vary the amount of principal repaid and the amortization period, and you'll quickly see how to increase home equity and lower the cost of borrowing -- interest -- in the process.
For more on information:
- On the federal government's interest-only mortgage option that defines products available in the marketplace. (Plus other mortgage changes).
- Another example of an interest-only mortgage product.