One of the benefits of home ownership is the ability to secure a loan against it, other than the primary mortgage. This can be done through a home equity LOC, or a second mortgage.
A few years ago I was part of the young and prudent group of people in their early twenties who bought a home in Canada when we could still amortize an insured mortgage for 35 years. I bought a $230,000 apartment with a $15,000 Down Payment which unfortunately meant I had to purchase insurance. Who at that kind of age can afford a 20% DP anyway?
Most Canadian banks will let someone borrow against their property up to 80% of the market value. They call this the loan to value ratio. 80% LTV ratio gives the lender a 20% margin of safety, meaning local house prices would have to drop 20% before the bank will be at risk of losing money.
Maximum I can borrow = 80% of property value = 0.80 x $230,000 = $184,000
My mortgage balance in April 2009 = $215,000
Difference = -$31,000
Since I’m already borrowing more money than what my LTV amount will allow, I can’t unlock any potential liquidity in my home
Okay, now fast forward to today. By only ever paying the minimum on my mortgage payments the balance on my mortgage has barely changed. Today my mortgage balance is about $202,000. You’re probably thinking cheese-&-rice, Liquid, after 4 years you’ve only managed to pay off 6% of the initial principle? I know. It’s not very impressive :P, but that’s just how I like to roll
Earlier this year in April I blogged about how I won a farm at an auction and had to raise $25,000 to complete the downpayment by August. Luckily the purchase deadline has been pushed back until October, but I still need to come up with the money nonetheless. So back in May I decided to apply for a Home Equity Line of Credit with CIBC. The appraisal came back valuing my apartment at $280,000
Maximum I can borrow = 0.80 x $280,000 = $224,000
My mortgage balance in May 2013 ~ $203,000
Difference = $21,000
Ding Ding Ding! I can get another loan The entire application process took about 5 weeks. Afterwards I saw that a new HELOC has been added to my list of Credit accounts. I haven’t used it yet but I will when I require the money.
For a long term investing strategy I believe it’s much more effective to invest aggressively, especially when you’re young, rather than pay down the mortgage quickly. I could have committed an extra $200 every month towards tackling my mortgage. But that wouldn’t even add up to $10,000 over the last 4 year period, which is almost laughable compared to the property appreciation realized in the same amount of time
Just imagine the massive savings effort it would take for someone to pay down an additional $50,000 off the principle on their mortgage Now imagine someone else who buys a 2nd home, waits around for several years, and also experiences a $50,000 net worth increase. Which person would you like to be ? Nobody ever gets rich by paying off their debts We get rich instead by continuing to build our asset column. This is exactly why I chose to put my savings into acquiring that farm (an asset that will generate $5,000 of income per year) instead of into the equity of my home.
I know Vancouver’s real estate market is a bit of an anomaly. But throughout Canada, most cities have seen a pretty consistent demand for housing. Even locations with urban sprawl show no signs of deflationary pressure. In Edmonton for example, the number of homes sold last month in July was almost 25% higher than the same time last year.
Some people say you shouldn’t count the equity in your primary residence as part of your net worth because you can’t sell your kitchen. Well maybe those people just don’t know how to unlock all that potential liquidity which can be used for emergencies, university tuition, a second car, a long vacation, investing, or anything else they want (゜∀゜) as long as they use it responsibly. It’s true you can’t “spend” your home per-se, but you can make use of it’s value for financial purposes Next week I’ll post how to open up a HELOC so you can unlock the potential of your home too