Home equity in the age of a recession: How can it help?

Economists are predicting a downturn in the Canadian economy this year, as many have pulled back their spending following the Bank of Canada’s eight policy rate hikes. While the series of hikes was intended to slow the economy and cool inflation, economic activity may need to slow even more than expected to get excess demand under control.

With a looming recession, need-based borrowing is on the horizon, as both mortgage debt and non-mortgage debt rise. Borrowing against home equity can be a critical tool for those looking to supplement their finances.

“With rising costs and wages not following as fast, people will need to use the equity in their homes to make up the difference,” says Mark Cashin, principal broker at Cashin Mortgages. “If you’re short on funds at the end of the month, it can offset the $100, $500, $1,000 cost of living increase or help you refinance high-interest debt into a lower single payment.”

Though higher variable rates have made it more expensive to tap into a home equity line of credit (HELOC) than it was a year or two ago, this lending option and others like it still offer an opportunity to borrow funds when you need to most.

How can you use home equity to help free up cash flow in a recession?

Many Canadians are worried about the financial implications of a recession, but property owners can use home equity to provide some financial relief. The amount of home equity you have depends on the current value of your home and the balance on your mortgage.

For example, if your home is worth $500,000, and you have $400,000 left to pay on your principal, you can access $100,000 of home equity. There are a few ways to do this, and each method has its pros and cons. While some borrowers may simply benefit from more cashflow through a HELOC, others may be forced to refinance their mortgage in more drastic scenarios. In either case, this year may see more willingness to borrow against one’s own home equity if they’ve never considered it before.

Borrowing against home equity can be done in the following ways:

Home equity line of credit (HELOC)

A HELOC is a revolving line of credit that you can borrow and pay back repeatedly up to your credit limit (up to 65% of your home’s value). Your rate is generally set at the bank’s prime rate minus 25 basis points. However, the HELOC is a variable-rate product, meaning the interest will fluctuate with the market.

“It's a great tool for borrowers that have an existing mortgage at a great rate and don’t want to break it to get into higher-cost financing,” says Cashin. “It’s also greats for individuals that have the ability to make large lump sum payments. A HELOC allows you to make large principal payments without a penalty and the balance remains available for future use.”

There are some administrative fees involved with the loan, including appraisal, title search, title insurance, and legal fees. But the flexibility of the product can be worth it, so long as you maintain a manageable loan that you can one day repay.

“You only pay interest on the funds you use, but you have access to funds if you need them, and it’s a lot less expensive than credit cards that compound daily,” says Cashin.

Reverse mortgage

With a reverse mortgage, you can borrow a maximum of 55% of your home’s value. This product is only available to homeowners who are 55 years old or older.

“The number one difference between a reverse mortgage and any other is that it’s a non-recourse mortgage,” says Cashin. “Meaning if you don't pay it at the end of the month, the lender can’t trigger enforcement like traditional mortgages. I.e., you can’t be evicted for not paying your mortgage.”

This type of mortgage can help older Canadians maintain financial independence in their later years. But keep in mind, when the borrower dies, their estate must pay the balance.

“Seniors can stay in their homes longer or use the funds to help pay Personal Support Workers. With fixed income, it’s a way to offset increasing costs like property tax, gas, and hydro bills,” says Cashin. “Seniors don’t have to raid their savings and be taxed.”

Refinance your mortgage

When you refinance your current mortgage, you can borrow up to 80% of the appraised value of your home. This is different from its market value, meaning, what buyers are willing to pay for it. However, if you opt to refinance, any outstanding loans secured against your home, like your mortgage or HELOC balance, must first be subtracted from the 80%.

You can talk to your lender about refinancing your home by taking out a second mortgage, starting a HELOC, or another line of credit secured by your home.

While refinancing wouldn’t currently put you in a better off position interest rate-wise, it can offer a timely solution to a financial emergency (for example, losing your job).

Second mortgage

Again, with a second loan on your home, you can borrow up to 80% of your home’s appraised value, less your original mortgage balance. Both mortgages have to be paid off simultaneously. Keep in mind, second mortgages are riskier for lenders, and tend to come with higher interest rates, plus the usual admin fees.

Borrow what you’ve already put down on your home

Another way of using equity in a pinch is re-borrowing the money you’ve prepaid on your mortgage. For example, if you’ve made any lump sum payments in the past to lower the amount of interest you’re accumulating, you can borrow that money back. The total you reborrow may come with a blended interest rate that partially reflects today’s rates, so talk to your lender.

Outlining your concerns with a broker and comparing mortgage rates can help identify the best plan of action for taking advantage of the equity you’ve built in your home.

“Like all mortgage solutions, it needs to be tailored to the client's situation at the time,” says Cashin. “The decision will be based on the past, but more importantly, where the borrower wants to be in six months, twelve months, three years, or five years.”