The Truth About Home Equity in 5 Minutes

Home Equity.


We all strive for it. I mean, this is the sole reason we purchase a home for ourselves, isn't it? Something for us to work towards, pay off, hang the flag out front, and pass along to our kids and generations to come.


That's the goal when it comes to homeownership, isn't it? Equity.


But what is home equity and are we using it the right way to set up our future generations to reap the benefits going forward? Let's take a deep dive and find out.


I'm Aly, a local Calgary real estate agent, born and raised in Calgary. I love my job because it allows me to help those that want to achieve homeownership the pathway to make that goal a reality. I help on average 20 home sellers and buyers each year achieve this goal.

Now, let's start at the top.


What is Home Equity?


As defined by the government of Canada, home equity is:


"Home equity is the difference between the value of your home and how much you owe on your mortgage."


If you had a chance to check out my last blog, "Is Buying A Home Worth It?" we can continue the example used to illustrate what equity looks like.


If you purchase a home for $150,000 and it is now worth $500,000, the difference in the amount of the home is $350,000. This is considered your home equity.


Because your home has $350,000 of equity in it, depending on the financial institution, you are able to access this equity through borrowing and a loan.


You are allowed to borrow up to 80% of the value of your home to liquefy the equity after any existing mortgages, credit lines, or loans secured against your home for use in your lifestyle. Some reasons you may want to take a loan against your home can be:

  • a death in the family

  • a wedding in the family

  • unexpected expense

  • child's education

  • etc.

When you do this, you are using your home as collateral (securing) for the loan. This means that if you are unable to repay this loan for the amount taken, your home becomes an asset that can be targeted for creditors.


Why are Home Equity Loans Needed?


As mentioned above, life happens. You can be faced with a drastic need for funds immediately for some of the reasons above. Other reasons can be due to job loss, tax issues, etc.


But one reason, that is becoming more and more prevalent is the use of a home equity loan to aid future generations with homeownership.


In some parts of the country, home values have skyrocketed. When this happens, homeowners have access to more funds from their homes due to the increased value.


But their children are seeing the short end of the stick with higher prices and not being able to qualify for funds.


So what is the obvious solution (depending on how generous the parents are)? A gift of a down payment using their home as the collateral for the gifted amount.


I use the word "gift" because it has to be just that, a gift. There cannot be any kind of agreement of repayment for this down payment to allow it to be used for the child's home purchase.


So in a home in Toronto for example, a conventional mortgage would require a down payment of $200,000 to purchase a $1,000,000 home.


How This Can Get Dicy Fast!


In the above example, the kids are in a great position to purchase a home, with a healthy downpayment.


The parents on the other hand now have an additional $200,000 worth of debt added to their home. Hopefully, in most cases, the home may be paid off or near to there and the parents have the ability to service and pay the loan amount off for their home.


If not, they may need to sell their home to come out of the loan payment. Which no one wants, especially in the market Toronto is in right now.


Where would they go? How much more would they need to pay to find a home?


And if most parents are nearing the age of retirement, servicing the debt might be a hard layer to add on considering their drop in income and increased cost for medical bills.


But that is just one side of the coin.


On the other hand, the children have now just committed to an $800,000 mortgage that they need to pay for the next 25 years. Using a rate of 2.0%, this would cost them about $3,400/month.


This equates to $40,800 a year. The average salary in Toronto before taxes is $66,000 according to payscale.com


You can see where the problem starts to come in to play for the kids. One entire income will need to be dedicated to the mortgage alone.


And If This Continues?


As we continue to see an aging population of seniors relying on more and more social programs, we will see more and more costs being pushed to the younger generation to maintain.


This means higher taxes for social programs and higher property taxes as more and more development comes up making land more and more scarce.


And as more and more first-time buyers overleverage themselves to get into homeownership, their quality of life will be affected. To just getting by with higher food and service costs, less saving for future generations, and the creation of a negative loop of issues due to not earning enough to cover all the costs.


So when the government tries to increase supply into the market to ease pricing this is a good thing. More housing means more competition, which means better pricing for buyers.


But what is the real solution?

Families had it right a few decades ago where the entire family became a unit. Most cultures today still follow this mindset and have more than one or two incomes coming into the household. Each income contributes to pay down expenses and increases the wealth of the entire family moving forward.


In Calgary and Alberta generally we don't have these astronomical prices, which puts us in a great position for future generations.


More and more I work with first-time buyers that have started their careers and live at home. Saving, building their wealth, and purchasing property with ease to grow their families and continue to the loop. Some actually still live at home, contribute to the home, own investment properties, and are thriving with building their wealth and asset portfolios before leaving home.


So what is my solution? In my humble opinion, our country is so much more than the two centers that have this bubble of equity issues. We should work to develop these other centers, grow the population into the west and central Canada. Build economies to attract young professionals to want to work in these areas.


Give them the chance for fair homeownership and allow the following generation to thrive for the years to come.


But the first step has to come from those first-time buyers in these two bubble centers. The leap of faith of purchasing a home in a new area and knowing they can make it their home, just like their parents before them. Our other major cities are ready to thrive and grow, we just need the population in two major cities to see the benefit.


Thanks for your time as always, I hope this helps.


Take care,

Aly

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