HOLIDAY HOMES
Chart a clear strategy before getting a home-equity loan
Financing a vacation bolt-hole,
After a long, harsh winter in the city, what homeowner hasn’t dreamed of packing up the family and driving north to their very own cottage on the lake.
And it could all be yours, if you’ve built up at least 20 per cent equity in your home: using your property as collateral, you can take out a home equity line of credit (HELOC) and use that cash for a down payment and closing costs. But is the road to owning a vacation property truly that easy, and should you go down it?
A home-equity loan allows you to borrow up to 80 per cent of your home’s current value, minus what you still owe on your mortgage. A HELOC will give you access to 65 per cent of your property’s value; you can top that up to 80 per cent with an “increase and blend”: increasing your mortgage and blending the new interest rate with the existing one. However, if you’ve got a variable mortgage to begin with, depending on your lender, a HELOC may be your only option, unless you want to break your mortgage and refinance it entirely.
Michael Marini, a mortgage agent with Dominion Lending in Toronto, says the main thing to consider when leveraging your home equity to buy a vacation property is your budget. “I look at everything in terms of what clients personally can afford, not what they can be approved for,” he says. “People have to still be able to save and build equity. If they can’t do that, then my advice would be no. It’s got to make sense in terms of cash flow, savings and overall equity in their long-term planning.”
So yes, there are a few things to consider before the “sold” sign goes up on your new cottage in the woods.
The real cost: Consider how long you intend to carry the debt, and how good your saving habits are. If you know you’re not going to be able to pay it off right away, a HELOC, which typically has interest-only payments, is relatively cheaper than a loan. It also allows you to forgo the legal fees (at least $1,000) associated with refinancing a mortgage. The downside? Unlike a mortgage, it may never go away. “You buy a cottage, and then you find out that, wow, it needs a new roof or a boiler system, so you keep drawing on this line of credit over and over, and you overextend yourself,” says Marini.
And while today’s rates are quite low, says Nawar Naji, a mortgage broker with Verico in Toronto, you have to consider what you’ll be paying on that line of credit in five years when the prime lending rate inevitably goes up. “Sometimes, for undisciplined homeowners, the line of credit tends to turn into a bank machine,” he says. “I stress discipline. Treat it like a mortgage. You’ve got to pay it down. You can’t just leave it sitting there like a credit card and paying the minimum interest.”
Protect your primary residence: Recent government changes to banking regulations have almost ensured that you can’t financially overextend yourself, but consider this: If the market value of your home drops, you could find yourself on the hook for more than it’s worth. You’ve put your family home on the line, so if you miss a few payments on your home-equity loan, depending on the lender, you could face foreclosure on your original home.
What’s your game plan? Think about possible lifestyle changes. Naji suggests looking at how decreasing your cash flow could affect budgeting for things like daycare costs in the future. “It’s difficult to predict, but one has to contemplate lifestyle changes because future needs will impact whether you own or sell that cottage. And the cost of buying and selling is expensive — there are land transfer taxes, real estate fees, legal fees to take into account.”
Naji also asks about clients’ “exit strategy” when purchasing a vacation property: how long do they intend to keep it, will they pass it on to their children, and how often do they plan to use it?
Regardless of how easy home equity is to access, Naji stresses the importance of planning. “It’s not just strictly get a mortgage, and here’s the interest rate and we’ll talk to you later: It’s a financial planning approach with the family or client to understand how that cottage would fit into their overall financial wellness from a long-term perspective.”