When our second child was on the way, my wife and I took a look around and realized we were running out of space.
Our 3-bedroom townhouse would still be big enough for our family, but we wanted room for our guests to stay, a place for the kids to play, and a way to get more use out of our home. So, we looked downstairs and dreamed about finishing our basement.
There’s a problem with renovation projects, though: they’re expensive. Even though we were able to find an awesome contractor, do a bit of the work ourselves, and get deals on some of the components like flooring, the project still cost close to $20,000. And we just didn’t have the money available to pay for the work out of pocket.
Fortunately, we were able to access equity in our home to pay for the job. And whether you’re planning to finish a basement, remodel a bathroom, or finally update your very dated kitchen, you may be able to borrow money secured by your home to do the work.
We didn’t want to borrow tens of thousands of dollars without making sure it was a good investment, so we started by asking our real estate agent to come over and talk about the project with us. She helped us look at comparable homes that had recently sold in our neighbourhood to get an idea of what value we would add by finishing the basement.
Our agent was also able to make recommendations about what potential buyers would look for in a finished basement. For example, she strongly advised we not build out any rooms, but leave the space open and subdivide it with furniture instead. And she was right & the space is bright and open, and we expect to get our investment back when we sell the home.
Armed with the knowledge that our investment was a wise one, we started work on getting financing. We called our mortgage broker and they gave us four options for accessing equity in our home to fund our renovation project:
A new mortgage
In this scenario, we would break our current mortgage and get a brand new one. We would be allowed to take out up to 80% of the value of our home, and we would receive a one-time lump sum amount. We would then make a single monthly mortgage payment based on the new borrowed value.
By getting a new mortgage, we would also be able to access the best mortgage rates at the time.
To get a new mortgage, we would have to qualify just like when we bought our home. We would have to show we could make the new mortgage payments, and all of our other debts, and stay within the maximum debt service ratio.
The downside to this option was that we would have to break our current mortgage and pay a penalty. At the time, we were only about half-way through a five-year mortgage term, and it was going to cost several thousand dollars to break the mortgage. There would also be fees associated with getting the new mortgage set up, including legal fees. For that reason, this option is best explored at renewal time.
A second mortgage
Rather than break our old mortgage and start from scratch, we were also given the option of adding a second mortgage to our home. Just like if we had gotten a new mortgage, the total value of both mortgages could add up to a maximum of 80% of the value of our home. But rather than a single monthly payment, we would repay the second mortgage separately.
Aside from that, all of the rules would be the same. We would have to have the home appraised to prove the value, prove we could pay both mortgages and all our other debts based on our income, and hire a lawyer to register the mortgage and process the transaction.
Like the first option, a second mortgage would allow us to access equity only once. We decided that it wouldn’t be worth the setup costs to get a second mortgage because we were looking for a relatively small amount of money.
A blended mortgage
The third option was really just a combination of the first two. Rather than break our mortgage and get a new one, or get an entirely separate second mortgage, we were given the option to refinance through a blended mortgage.
Essentially, the term and interest rate of the second mortgage would be blended with those of the first mortgage. We also had the choice of whether to blend to term, where the math is done so everything lines up with the end of the original mortgage term, or to blend and extend, where we would commit to a new 5-year term starting from the date our refinance funded.
Just like the other options, the blended mortgage would involve some lawyers, go up to a maximum of 80% of the value of our property, and be subject to our ability to pay the loan.
Blended mortgages are a good option because they allow you to refinance without breaking your mortgage, and you can avoid the complexity of having multiple loans with different rules and payments. They can also help you access lower mortgage rates without breaking your mortgage if rates go down over your mortgage term.
But we thought a blended mortgage would be better suited if we needed to borrow a larger sum of money. Just like the other options, it didn’t seem worth the hassle for the size of the project.
A home equity line of credit
The fourth option we were given (and the one we ended up choosing) was a home equity line of credit (HELOC) that would let us open a revolving line of credit, secured by the equity in our home.
HELOCs work similarly to credit cards. You’re given a credit limit of up to 80% of the value of your home, less the amount owing on your mortgage, and you can make withdrawals and repayments of any amount at any time. The minimum monthly payment is just the interest that’s accrued.
The most appealing part of the HELOC to us is that we could get approved for a much higher credit limit than we needed. Even though we only used it to pay for our basement renovation, we still have a large line of credit that’s available to us if we decide to do other projects.
It wasn’t a limiting factor for us, but it’s also worth noting that HELOCs are easier to qualify for than mortgages because you only have to show you can repay the interest, as opposed to payments of principal and interest combined. But there’s the risk that you can carry a large amount of debt indefinitely, and end up paying a lot more in interest than you would with a mortgage.
In order to get the HELOC set up we had to go through the application process including income verification and an appraisal. We also had to hire a real estate lawyer to process the transaction.
A side note on appraisals & we learned through this process that the appraised value of your home plummets dramatically if there’s ongoing construction at the time of appraisal. They agreed in our case to appraise the home based on the main living area and not consider the basement, but to spare yourself a headache, try to make sure you have your financing in place before starting a project.
A mortgage broker can help
Regardless of how you choose to refinance to fund a renovation project, many of the factors are the same. In all cases, you’ll need to prove you can make payments, go through an application process, and enlist a real estate lawyer. Depending on your income, you might be able to borrow up to 80% of the value of your home in total, including your outstanding mortgage and the amount you borrow for your renovation.
The differences are mostly in the way you combine the loan with your existing mortgage and make payments. You can get a completely new mortgage, add on a second one, blend two mortgages together, or get a line of credit.
Once you’ve talked to your real estate agent about the value of your renovation project, your next call should be to your mortgage broker. They can help you understand your options, work out the amount you would be able to borrow, and get the process started for you.
Whatever your renovation project looks like, you may be able to fund it by refinancing your home. Talk to your mortgage broker to learn about the best financing options for you.
By Jordan Lavin for RateHub.ca