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Essentially the extreme danger of this product is you work hard, pay your bill monthly, and at the end of the year, or many years for some Home Equity line of credit borrowers you have nothing to show for your payments as you have not repaid any principal. There is a reason why there is so much marketing behind the Manulife One, RBC Home line, and other bank offered Home Equity lines of credit in Canada – by selecting this product you are a tremendous profit source for them! The sad truth is many borrower are sold on flexibility and have the best intentions to repay their debt however in my experience very few clients do this.
Lets look at the true cost of this borrowing via a Home Equity line of credit in Canada:
Assuming an average borrowing amount of $300 000,
Line of credit rate at prime (currently 3.0%) +.5
Variable mortgage at prime -.75.
Year one interest cost for the mortgage: $6646
Principal repayment: $7096
Monthly payment of: $1145
Year one interest cost for the line of credit: $10 500
Potential principal repayment or investment funds available from lesser payment: $3240 (($1145 -875) *12)
Monthly payment: $875
The final numbers:
Year one difference in interest cost: $3854 saved by the mortgage
Year one difference in principal repaid/ payments saved: $3856 by the mortgage
It gets even better….
Five year difference in interest paid: $20 912 saved by the mortgage
Five year difference in principal repaid / payments saved: $20 920 saved by the mortgage
The traditional selling points for a Home Equity line of credit versus a mortgage typically include:
- You can repay any amount at anytime so it is flexible – this is a load of bunk for almost all clients as mortgages typically offer prepayment ability as well, in amounts typically in excess of most borrowers capacity. With a 15% repayment ability on a $300 000 you are able to repay $45 000 per year without penalty.
- You can consolidate all of your debt in one convenient area – this is true, however it can also be done via a mortgage with significant interest savings.
- It’s a line of credit, not a mortgage – for some reason increasing a line of credit is no issue to some borrowers but taking out a mortgage is a major one. Lets see if a line of credit is basically a mortgage:
- Registered on title – check
- Lender can foreclose if not paid – check
- When you home is sold it has to be repaid – check
Sorry folks, it is a mortgage.
- The money you save on repaying the principal can be invested elsewhere for a higher return – Wow you must have the most amazing investment opportunity and returns to invest $16 200 saved in principal payment over 5 years and turn it into $41 832 to only break even on your additional interest cost and lack of principal reduction that you would have received with the mortgage.
The truth behind the Home Equity line of credit in Canada:
- When you walk into RBC, BMO, or call Manulife, they look at you and your line of credit as a long term profit source, that in many cases is never repaid, and that they can charge you a higher than mortgage rate for the illusion of “what if” flexibility.
The next time you are offered a Home equity line of credit without a specific reason and method of repayment, ask yourself is this good for me or the bank?