BC Sunshine Coast real estate by Menno at Royal lePage Real estate on the BC Sunshine Coast

Money comes and money goes – nobody knows that better than your favourite banker. Borrowing money, that’s what most people need to do to facilitate a home purchase – the banker knows that to by many different terms.

Most people assume five-year money when they sign up for a mortgage - but it must not be like that. There are many other possibilities available, these days.

A mortgage loan can be structured in many ways, although most people would first think of a “5-year fixed rate mortgage” or of a “variable rate mortgage”. The alternatives run from “open” mortgages (ones that you can pay back without a penalty at any time) to fixed-rate mortgage loans that are closed for 7 or 10 years.

One alternative that may interest certain home owners is the Home Equity Line of Credit, a product that has significantly got more popular over the past decade or so. The loan works like a Line of Credit, only that it’s secured by real estate. It’s a readvanceable product that would appeal most to people finding themselves in one or more of the following situations:

• Investment, business and rental property investment borrowing;
• Borrowing for education of self or family members;
• One-time debt consolidation as an alternative to higher-rate loans;
• A down payment source for another property;
• An emergency backup fund that may or may not be touched.

After tremendous growth, the line of credit mortgage has suddenly become less available. This is because the government considers them too risky for many borrowers.

PUTTING THE BRAKES ON HELOC LOANS

The rules for Home Equity Lines of Credit are changing. Newly underwritten lines of credit will have to be limited to 65% of the home’s appraised value. Most banks have been reporting a steady growth on secured line of credit products over the past years. They are, in fact, mortgage loans with special revolving credit features. In an effort to bring down Canada’s dependency on cheap mortgage money, we’ve seen the government bring in various rules lately to cool the mortgage market a bit. The next instalment in this is targeting Home Equity Lines of Credit. This kind of mortgage product has been on offer by various banks to those that require a more flexible source of mortgage money than a straight mortgage, be it with variable or fixed rates.

Instead of choosing a variable rate mortgage, many people have recently been opting for the security of fixed-term mortgages, mostly of the 5-year variety. If they both cost about the same, then most people will opt for the safest option; that’s a human reality. The one in which they can be certain that their payments won’t go up for the full duration of their mortgage term. The current success of fixed-rate products is easily understood in such a context.

One could expect that the decline of variable rate mortgages goes hand-in-hand with the popularity of HELOC products – but it turns out that this is a completely different market with different customers and a completely different target group. HELOC mortgages are variable rate mortgages, of sorts. They are open in that they can be paid off without penalty. They are also re-advancable.

The Home Equity Line of Credit type of mortgage now falls into the category of loans that are available to those that don't really need to borrow the money in the first place.

A LOAN FOR THOSE THAT CAN AFFORD THE LUXURY

Instead of the usual mortgage product (standard fixed-payment mortgage or variable rate mortgage), the Home Equity Line of Credit has become quite popular, particularly to home-owners with an above-average credit standing. A HELOC, in one form or another, is offered through virtually all major banks and credit unions. It is a flexible mortgage loan in which the lender agrees to lend a maximum amount within an agreed period (called the term). The collateral is the borrower’s equity in his/her house.

A HELOC differs from a conventional mortgage loan in that the borrower is not advanced the entire sum up front, but uses a line of credit to borrow sums that total no more than the credit limit, similar to a revolving credit facility. Funds can be borrowed during the “draw period” (typically 5 to 25 years). Many HELOCs ask for monthly repayment of only the accumulated interest. However, the home owner may make a repayment of any amount so long as it is greater than the minimum payment. The full principal amount is due at the end of the draw period. It’s a mortgage loan that needs to be repaid like any other loan. However, you have more freedom to pay it off faster, take money back out, lock in portions and so on.

An important difference from some conventional loans is that the interest rate on a HELOC is variable. It’s a bit higher than the rate on a standard variable-rate fixed-term mortgage. One could see that as a premium for the privilege that one can pay back any amount of the loan at any time without penalty. The interest rate is generally based on the prime rate, moving up and down with it over time.

Within a Home Equity Line of Credit, you can sign up for a fixed portion of your loan, taking away from the risk of fluctuating interest rates.

FIXED WITHIN VARIABLE OPTION

Within the HELOC, most lenders permit the borrower to “lock in” a portion of the loan at current fixed-term mortgage rates. The advantage in that would be when one expects mortgage rates to go up significantly in the near future. Once an amount is locked in, it’s no longer possible to make unlimited repayment without a pre-payment penalty. Most lenders will apply standard pre-payment privileges and penalties to the fixed-term portion of HELOCs.

A HELOC is currently still available up to 80% of the appraised value of the home, subject to the standard income and credit worthiness checks. The sense of freedom offered by HELOC mortgage products is appealing to many. However, it’s only suitable for those that can handle this kind of freedom with discipline. Those prone to drive themselves into more and more debt should probably stick with a fixed-term, fixed-rate product for their own financial security.

A “problem” with a HELOC mortgage product is that the re-advanceability of the principal could be abused by those prone to bad money management habits. The easy availability of money cannot be handled by all – some would actually be too eager to spend it all.

Ever since the government put the brakes on HELOC type mortgage loans, creativity in lending has further come to the fore in many other forms.

FLEXIBLE FINANCIAL PRODUCTS:

HELOC loans became very popular over the past years. A reason for this popularity is their flexibility, both in terms of borrowing and repaying on a schedule determined by the borrower. Furthermore, HELOC loans’ popularity growth may also stem from their having a better image than a second mortgage, a term which can more directly imply an undesirable level of debt.  Of course, within the lending industry itself, a HELOC can be categorized as a second mortgage, if already there is a first mortgage on record.

A HELOC loan gets registered as a mortgage, just like any other mortgage. Failure to repay the loan or meet loan requirements may result in foreclosure.

A HELOC loan is ideal for those with fluctuating incomes and payment discipline. If one were to view the HELOC as a source of “free money”, it will quickly become a drain on the future. Some people prefer the security of a traditional fixed-term mortgage, either with a fixed rate or even still with a variable rate. Others prefer the freedom to pay off the loan when they choose – and perhaps take out money again when they like. The HELOC is not for everybody but it can certainly be an interesting option for many. Ask your banker, mortgage specialist or mortgage broker!

PLEASE NOTE: mortgage advice does not come from this website. To get the full picture, please make an appointment with a trustworthy financial professional.

Reading more about financial topics will set you up well for a meeting with a financial specialist. It helps if you know what you're talking about.

MORE mortgage and finance related topics can be found in the following blog articles:

Such low mortgage rates are real? http://www.mennorealty.ca/Blog.php/record-low-1

The average $151,000 mortgage: http://www.mennorealty.ca/Blog.php/mortgage-151000

Lessons about your credit score: http://www.menno.ca/?p=19847

An insured mortgage or not: http://www.mennorealty.ca/Blog.php/80-or-81percent

Getting out of a mortgage contract at a price: http://www.menno.ca/?p=19890

What is title insurance? http://www.menno.ca/?p=19836

Favourite banker terms: refinance and renewal: http://www.mennorealty.ca/Blog.php/renewal-1