Homeowners should know the differences between a conventional mortgage and a Home Equity Line Of Credit (HELOC).
A conventional mortgage is a registered charge against your home. There is a set term – 6 months to 10 years with a fixed or variable interest rate. Payments include principal and interest. Many homeowners choose a fixed rate as it is easier to set budgets knowing the interest rate won’t change during the chosen term. Variable interest rates will change as Prime rate changes. You can purchase a home with as little as 5% down payment. If you have less than a 20% down payment (equity) the maximum amortization is 25 years. With more than 20% down, a 30 or 35 year amortization is available.
A HELOC is a secured line of credit also registered as a charge against your home. This charge can be in first position but generally is added behind a conventional mortgage. Some lenders will not permit another charge on title. Like any line of credit, a HELOC is fully open and you can borrow, re-pay and re-borrow. The interest rate is tied to the Prime rate and may fluctuate. Canadian Government regulations stipulate that a HELOC cannot exceed 65% of the value of your home, unless in second position when combined with a mortgage, in which case you can borrow to 80% of the value and qualifying must be done on a 25 year amortization using the government regulated benchmark rate. Payments can be as low as interest only but that should truly be the never-never plan for repayment. Any spikes in interest rates can throw off the most dedicated budgeters!
If used responsibly and with a sound strategy, a HELOC can have many advantages. Purchasing investments with a HELOC creates a tax deduction for interest paid. Renovating your home with a HELOC allows you to draw from it when you need it, only paying interest on the money used. Your children’s education, buying a boat or the down payment for a recreation property can all be facilitated with a HELOC. A HELOC can be a great tool for investments, renovations and short term financing needs. For anything longer term, however, it is often cheaper to choose a conventional mortgage with a variable rate. The difference in the lower interest rate outweighs the flexibility of the HELOC.
When buying a home, most people take a conventional mortgage with a fixed term and rate. The astute homeowner understands the power of a conventional mortgage combined with a HELOC. Understanding your needs together with a strong financial strategy can quickly turn your largest debt into your greatest asset!