After the recent decline, the stock market appears to be at or near the bottom and ready to reverse direction. For those homeowners whose retirement portfolios have suffered in the last while or need to invest to build a retirement nest egg, now is the time to get smart about the opportunities available to them. Tapping in to the equity in your home is one such opportunity that may allow you to ride the "bull" market on its' way up.
The EQUITY in your home is calculated as the difference between your home's appraised value, minus your remaining mortgage balance. For example, if your home is appraised at $250,000 and your remaining unpaid mortgage is $100,000, the result would be $150,000 of total equity. However, for borrowing purposes you can refinance only up to 90% of the value of the home. 90% of $250K is $225K, minus the mortgage of $100K allows you to access $125K for investing. The actual amount a homeowner can access will vary depending on your credit history, outstanding debts, income, and the like.
There are three different ways to access your equity; a new first mortgage, a line of credit or a second mortgage. Each product has its' advantages and disadvantages.
New First Mortgage
This implies the replacing of the existing mortgage with a new one. If you're a qualified borrower, the rates will be extremely competitive and you will be able to refinance up to the full 90% of value threshold. The money is drawn down in a lump sum on one given day and the mortgage payable begins accumulating from that day onwards. In Canada, the interest payable on non-RRSP, investment loans is tax deductible. Therefore, the interest cost of the increased mortgage amount; the difference between the new mortgage and the existing mortgage, is tax deductible. The downside is this will be a high-ratio insured mortgage and an insurance premium will be incurred. Additionally, a discharge penalty may be payable to get out of the existing mortgage terms. There maybe some tax deductibility associated with these costs, so make sure you have a detailed paper trail for Canada Customs and Revenue Agency's (CCRA) benefit. I recommend you speak to your accountant regarding the taxation benefits.
Secured Line of Credit
A secured line is flexible and allows you access to your equity, only when you need it. Unlike a mortgage, you draw what you need and repayment terms apply only to what you have drawn down. If your financial plan calls for a staggered investment, this option would meet your needs best. However, a secured line of credit can only be placed up to 80% of the appraised value of the property. Referring to our example above, if you chose a secured line for your refinance, you will have access to only $100K (80% of $250K) and not the $125,000, as in the mortgage scenario. If you need the full 90% to accomplish your retirement income objective, this is not a viable option. The borrowing rate for a secured line is usually at prime which most often is below the fixed mortgage rates. Another advantage of a secured line is that you pay interest only on the amount you use, so you don't run up interest charges for unused portions, and using nothing costs you nothing. This makes for a lower monthly payment and the interest is tax-deductible as in the case of the mortgage loan.
Second mortgages-subordinate liens over a first mortgage-are most often used in refinancing when a 80% loan is not enough but 90% will do. By choosing this option you eliminate the pre-payment penalty for discharging a closed mortgage early and you eliminate the need for high-ratio insurance as in the case of a new first mortgage. However, since they create more risk for lenders, interest rates are higher than for secured lines or fixed-rate first mortgages, but over time they're less costly than refinancing the first mortgage.
You have lots of options and lots to think about. My best advice to you is to sit down with your financial planner and your mortgage broker and explore which options make sense for you based on your retirement income objectives.
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