Across North America, housing affordability remains a thorn in the side for young aspiring would-be buyers who have largely been priced out of the market. Several years of interest rate hikes by central banks, coupled with rising home prices and stronger-than-ever demand, have made purchasing a home nearly impossible.
Although challenging housing market conditions continue to persist, near-term improvements have started showing face on the horizon, which could potentially provide a turnaround for would-be buyers and current homeowners looking to purchase a secondary property.
Central banks are starting to cut back on interest rates. The Bank of Canada has already introduced several rate cuts recently and has more on the books for the remainder of the year. In the U.S., mortgage rates have fallen and continue to remain below their former peak, while the Federal Reserve is cutting interest rates and saying they will again before the year’s close.
As interest rates are being slashed, many are expecting a revival of the housing market, which could help bolster buying activity among current homeowners looking to use home equity to finance new housing endeavors.
First-time buyers might be in the same boat. Those who’ve purchased homes during the period of holistically low interest rates might have similar thoughts. However, with less equity available and perhaps more risk at hand, how can first-time homeowners navigate the road ahead should they be looking to leverage their home equity?
Home Equity: Canada vs United States
In North America, home equity can help current homeowners finance big-ticket purchases by taking out a loan against the current value of their home. In short, home equity is calculated based on the current value of a property and the remaining balance owed on a mortgage.
For instance, if a home or property is appraised at a value of $550,000 and the owner still has an outstanding mortgage balance of $250,000, the equity of the property would be $300,000.
Depending on the mortgage lender, owners may have the option to take out up to 75% of the equity of their home. In this example, that would mean that the owner would be allowed to borrow roughly $225,000 against the value of their home.
Keep in mind that not all mortgage lenders are this accommodating, and there are plenty of boxes that a person will need to have ticked off before being approved for a home equity loan.
Home Equity in Canada
Parts of Canada have seen property prices soar in recent years, largely due to stronger demand and a faster-growing population. The average house price in Canada has risen sharply, with prices going from $359,884 in 2018 to $477,900 in 2024, and with a forecast of prices reaching $531,559 by 2025, according to recent statistics.
Homebuyers who purchased properties in 2018 have experienced the greatest increase in property value, especially those who purchased property in more affluent cities and neighborhoods.
For instance, homeowners in the Greater Toronto Area (GTA) have seen the benchmark home price climb from $759,00 in 2018 to $1,161,200 in 2023, an increase of $401,700 or more in value. Unsurprisingly, the GTA is now the fastest-growing city and the fourth largest in North America.
The distribution of wealth is more evident in Toronto, as more high-end transactions and custom designs to build homes in the city are becoming increasingly present in neighborhoods such as Lawrence Park, Rosedale, Forrest Hill, Hog’s Hollow, and Bridal Path, which have seen listings of $10 million or more.
Favorable immigration policies have boosted Toronto’s population, with roughly 50% of people living in GTA and Canada born outside the country. This movement has helped to create new opportunities for property management companies, which have seen a rise in new clients living abroad but still owning property in Canada.
Similarly, in smaller cities across Canada, homeowners have witnessed significant gains in their property values following the pandemic surge in new buyers entering the market during a period of record-low interest rates. For instance, house values in the Hamilton-Burlington region have increased by an average of $314,400 since 2018. The average benchmark rose from $559,200 to $873,600 in 2023.
Home Equity in the United States
In the United States, homeowners have seen property values soar since the pandemic. According to LendingTree, American homeowners now have more than $28.7 trillion of home equity.
By this estimate, it’s possible that each owner-occupied housing unit in the United States currently has an average home equity value of $334,000.
The total value of home equity has doubled since 2017 and quadrupled since 2012 when the U.S. economy was recovering from the Great Recession. By early 2024, the total value of American housing equity reached $32 trillion, according to federal data.
The price of the average American home has reached stratospheric levels in recent years, similar to those in Canada. The luxury home real estate market has seen average listing prices reach new record highs, rising faster than the median listing price.
For instance, the median American home list price increased from $320,000 to $430,000 four years after the pandemic. However, high-end luxury homes have seen listing prices jump significantly, climbing from $1.5 million to more than $2.2 million during the same period.
Key housing markets, such as those in West Palm Beach, Florida, Lake Havasu City, Arizona, and Reno, Nevada, have seen luxury home prices double, with West Palm Beach seeing prices rise by 171% in the last several years. The average luxury listing price is now at $4.48 million, up from roughly $1.65 million.
The Benefits Of Using Home Equity
Current homeowners might be in a position to start thinking about how they can use changing market conditions to seize future opportunities. Many might be using the period of falling mortgage rates to refinance their homes or shop around for more affordable rates.
Another portion of homeowners, especially those who recently purchased a home in the last five or seven years, might be looking to take advantage of their current home equity to buy a secondary home. While not everyone might be in this position, those first-time second-home buyers could potentially tap their home equity to grow their real estate portfolio.
Debt consolidation
One of the most significant benefits of having home equity is the option to consolidate high-interest debt into a single loan. For instance, it’s possible to consolidate high-interest credit card debt with home equity, which usually has a lower interest rate than credit accounts. You can save money by cutting down on high interest rates through this approach.
Near or long-term investment opportunity
Another reason you might be interested in using your home equity is to direct the capital you take out toward a potential investment. Though this might seem like an excellent opportunity to grow your investment portfolio, you must consult a financial advisor or estate planner before making a big financial decision.
Retirement planning
Home equity can potentially provide you with a steady income during your retirement years should you have limited savings available. Using your home equity, you can supplement your retirement savings, allowing you to consolidate existing debt or potentially help improve your long-term retirement investment outlook.
Home improvements
One of the most common uses of home equity is to improve an existing home. Homeowners typically tap their home equity to renovate their house in the hopes of increasing its value. Many times, homeowners will use home equity to update their kitchens or bathrooms, as these are usually key selling points for would-be buyers.
Put towards a downpayment.
Another way to use your home equity is to put it towards the downpayment of another property. Many real estate investors and those wanting to grow their real estate portfolio will use available home equity to use as part of a down payment for another property. Before doing this, you must meet the eligibility criteria and ensure that your mortgage lender will allow you to take out a percentage of your home equity.
Emergency savings
Homeowners could also use their home equity to fund emergency expenses, including medical bills, maintenance, and repairs, or to supplement their income should they have lost their job. Using your home equity will avoid taking out personal loans, creating more debt with high-interest-rate credit cards, or tapping into your savings.
Paying off a mortgage
Using your home equity to pay off your mortgage loan is possible. However, this would simply mean that you are refinancing your mortgage balance, which might only make minor adjustments to your monthly payments. While you may be eligible to use your equity towards your mortgage, it might be wiser to use it for a second mortgage or fund an alternative investment.
Drawbacks Of Using Home Equity
While there are plenty of benefits to using your home equity to fund big-ticket purchases, there can just be as many disadvantages. Many homeowners often feel that because they have a high home equity they have more financial leverage to grow their property portfolio or even make other risky investments.
Taking out a home equity loan can present many drawbacks if you are not smart about your choices. It’s always important to consult with an expert, either a financial advisor or planner, to assist with seeking the most suitable financial solution for your needs.
Reduces available equity
If you decide to take out a loan on your home, you are lowering the available equity, meaning that you will have less leverage on your home should you need financial backing in the near future. Although you will inevitably reduce the available equity when you take out a loan, it’s important to think about what you will be using the money for and whether you will need to make another larger loan in the future.
Increases balance payments
Not only will you reduce your available equity, but you will also likely increase your monthly repayments. By taking out the loan on your home equity, you are withdrawing from the amount of money you have already paid towards the principal loan. After adjusting for the home equity loan and the remaining mortgage payments, you will likely be paying more toward your home than you did initially when you started paying.
Higher interest rates
Sometimes, the amount loaned on your home equity will be added to the existing mortgage balance, which might be subject to small-term personal loan interest rates. This would mean that although the loan amount is being added to your mortgage, you might be paying a higher interest rate compared to a mortgage rate. Ultimately, you will have an additional interest rate on your home loan balance.
Possibility of foreclosure
If you cannot repay your home equity loan or default on any of the loans, including your mortgage loan, your property might be placed under foreclosure. The conditions might be different in each case. However, a home equity mortgage lender might consider the value of the property and available equity before putting the property under foreclosure.
Increased debt
Taking out a home equity loan will only increase outstanding debt balances. While using home equity to repay other high-interest debt, such as credit cards or personal loans, consider how much more you will pay in equity loan charges, interest, and other fees. You should ensure you are comfortable and financially able to take on additional debt.
Larger borrowing amounts
With a home equity loan, you are required to borrow a large lump sum, which not only increases the amount of interest owed on the loan but can significantly lower the equity available on your home. Unlike a home equity line of credit (HELOC), where you can borrow smaller amounts, which in turn lowers the interest paid on those loans, a larger equity loan may place you at higher financial risk of having your property foreclosed or defaulting on your loans.
Things To Consider About Home Equity Loans
Before you take the plunge, consider the following factors that may influence your decision to take out a home equity loan.
Credit score
As with any type of loan, you must have a good credit score. Should your credit score have decreased in recent years since taking out the principal mortgage on your property, you will likely need to make improvements before being eligible for a mortgage loan.
Debt-to-income ratio
Lenders will review your debt-to-income ratio to ensure that you are in a suitable financial position before you have been approved for the loan. Generally speaking, you will need to have a debt-to-income ratio that’s not higher than 36% to 44%. This will mostly depend on the type of lender you work with and their eligibility requirements.
Eligibility requirements
On top of those abovementioned requirements, you must ensure that you meet all eligibility requirements set out by the lender. There are instances where a lender will have additional requirements, which can influence the outcomes of your loan application and how much you are likely to repay.
Market volatility
Current market conditions have shifted and remain uncertain. This might increase the level of risk a person is likely to face when taking out a home equity loan. Instead, consult with an advisor or estate planner to assist with finding more suitable financial solutions.
Availability of equity
In the most common instances, you will need to have roughly 20% of home equity available in your home before you can be eligible for a home equity loan. While some lenders might have smaller requirements, you might need to increase the available equity level in your home before you can be approved.
Finishing Thoughts
A home equity loan can be a smart way to supplement a big-ticket purchase or make additional financial investments. Make sure that you consult with a financial advisor before making any serious financial decisions.
Keep in mind that your home equity is tied to your home, and if you are unable to repay your mortgage or your home equity loan, your property might be foreclosed on. Always stay on top of your payments and avoid defaulting on any loans.
Building home equity can take years and even decades to accumulate. Make an effort to protect your equity by any costs, and only use this financial buffer should you have limited options or feel that a home equity loan will help better serve your financial goals.
Featured Image Credit: Photo by Kindel Media; Pexels
