Oran Hall | Using a house as loan collateral

QUESTION: I saw your article in the papers about using your house as collateral, and I would like to know the banks that allow it and your feedback on the matter.

— Coote

FINANCIAL ADVISER: There are several lending institutions, mainly building societies, banks, and credit unions that give home-equity loans, which are loans secured by the value of a residential property.

They are called equity loans because they are given against the owner’s equity in the property. The owner’s equity is the difference between the value of the property and any debts the owner has on the property.

Let me illustrate: If you bought a property for $20 million and borrowed $16 million to do so, your equity in the property would be $4 million. If, five years later, its value increased to $25 million and the mortgage balance declined to $14 million, your equity in the property would be $11 million.

The $11 million represents value that you can leverage to improve your financial situation if used wisely, provided, of course, that you are able to qualify for a loan and are able to service the debt satisfactorily.

A home equity loan may be had on a property on which there is no loan as well as one on which there is a loan. Loans officers are able to say how much you are eligible to borrow.

The lending institutions vary in the policies that guide how they lend, including the amount they lend, the term of the loan, the rate they charge, and what they lend for. How much they are prepared to lend is a percentage of the market value of the property and the maximum varies by lending institution.

There are cases, however, in which the maximum amount that can be borrowed is a set dollar amount, which may be less than the maximum expressed in percentage terms. Thus, although your property may have a market value of $30 million and the maximum percentage allowed is 85 per cent, the most you could borrow would be $15 million if that is the maximum allowed, and not the $25.5 million that would be equivalent to 85 per cent of the value of the property.

Where there is an existing mortgage on the property, the maximum amount that you can borrow is considered taking the sum already owed into consideration. Generally, it is tidier to get the equity loan from the institution that gave the first loan, and some lenders tend not to countenance their claim ranking after that of another lender.

Risk appetite

The property used to secure the loan may be one on which you live, it may be one being used by you as an investment, and it may even be owned by a third party, meaning somebody would be risking their property for you.

Among the purposes for which a home-equity loan can be used are home improvement, including repairs and expansion to increase the value of the property, educational funding to improve the capacity of the beneficiary to earn a better income, debt consolidation to reduce the cost of servicing more expensive debt, and funding medical expenses.

Some bolder people may even take the risk of borrowing to secure funds to invest if the lender is willing to lend for that purpose.

Lenders generally require the following to make such loans: the registered title for the property, a recent valuation of the property, a recent land surveyor’s report, evidence that property taxes and utility charges are current, a statement or invoice to substantiate the use of funds, a status report on the existing mortgage, if there is one, and building approval from the relevant authorities if the funds are to be used for expansion.

Lenders may require other documents and also require that borrowers provide proof of identity using a government-issued document that can be so used, proof of income, proof of address, and Tax Registration Number.

The borrower is also required to pay all the relevant charges that are incurred just as in the case of a first mortgage, for example, any government charges and the cost of the surveyor’s report. It is important to note that the lending institution will register a mortgage against the property to protect its interest.

Home-equity loans provide one means of using your untapped equity in a very valuable asset to increase your wealth. It should be used responsibly to finance projects that can yield long-term value and not so much to feed short-term desires, the benefits of which pass long before the loan is liquidated.

Paying such loans should also be a priority lest they go into default possibly leading to the loss of a very valuable asset and a decline of your wealth.

- Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. finviser.jm@gmail.com