Should you pay off your mortgage early with a secured home equity line of credit?
Helping you understand shortcuts.
There are tricks a borrower can use to pay off their mortgage faster, paying less interest to the banks.
I'd like to show you an example using "Sue."
Sue currently has an outstanding mortgage balance of $100,000 on her property. The mortgage interest rate is 4%, which costs her approximately $4,000 a year in interest.
According to a recent appraisal, her property is worth $850,000, and therefore, she has a mortgage of 12% of the loan to value.
Since the bank will give her up to 80% of the loan to value, or up to $680,000 (if she qualifies), Sue takes out a line of credit for $100,000 to match what she has outstanding on the first mortgage.
Now her property is mortgaged for $200,000 or 24% of the loan to value.
Instead of using the money she has taken out on a line of credit for purchases or other purposes, Sue pays off her first mortgage of $100,000 with the line of credit. The $200,000 debt is consolidated into just a line of credit of $100,000.
The line of credit's interest rate is Prime plus 1%, so approximately 5%, interest only, which costs her $1,000 extra a year, or $5,000 in interest.
You may be asking yourself, how is Sue getting ahead with paying more money each year in interest payments?
Sue has some savings sitting in a TFSA account and she's contributing to it with each pay cheque and earning minimal return. Here's a better option:
Sue has a TFSA account that has $20,000 in it. Instead of letting the TFSA collect interest at 1%, she puts it towards her “open” line of credit, meaning she can pay it down without penalty whenever she wants. Now she has a balance of $80,000, and she is paying only $3,000 a year towards interest, which is $1,000 less than she was originally paying on her first mortgage balance.
Therefore, Sue is saving over $700 a year because she would have only earned about $200 in her savings account.
As Sue gets paid, instead of putting some of her savings into a TFSA, she deposits it into the line of credit balance which enables her to pay principle faster due to it being calculated using simple, monthly interest instead of being amortized over twenty-five years or longer.
This sounds great but what are the dangers?
The home equity line of credit‘s interest rate can change. The Bank of Canada sets the overnight lending rate, which does fluctuate. Depending on the rates, this can alter how many savings one acquires and how fast they can pay off the line of credit and become mortgage free.
If the line of credit is not used often, one may be charged inactivity fees.
Most people have good intentions when they apply for a home line of credit. However, if someone finds themselves in debt, they could accumulate a balance on the line of credit, making it difficult to pay off. This would make the HELOC very counterproductive to the goal of becoming mortgage-free sooner.
Need mortgage advice? Depending on your unique situation, there are many options to explore to save you money, helping you become debt-free sooner.
Call today for a free consultation (647) 773-4849.
mortgage Interest rates 6% by 2020 as bank of canada tightens monetary policy.
It seems that the housing market in Canada has "somewhat" stabilized. Interventions to slow down growth and inflation commenced in mid 2016. From the collaboration of the provincial governments to the OSFI (The Office of the Superintendent of Financial Institutions), and the Bank of Canada, this intervention has now materialized into slowing the housing demand. In addition, there have been steady interest rate hikes, the introduction of the mortgage stress test which makes borrowers have to qualify for a mortgage using the current contract rate plus 2%, and taxes on foreign buyers.
There's also been some measures put in place to deter people from keeping properties vacant and some further restrictions on urban construction projects.
On a national scale, however, the Canadian housing market still has a long way to go before it gains the level of housing affordability that it had before the current measures were put in place. There is also a possible risk that higher mortgage rates and the current stress test persisting could hammer down demand in areas such as the Atlantic and Prairie provinces, would could lead to declining prices and less sales.
Due to all of the interventions noted, there have been significantly less overall sales. The only city that is currently experiencing price growth is Toronto after a year of steady declines.
Also, despite the relatively low national inventory-to-sales ratio, the new-home market now faces weaker demand than at any time since the 2009 downturn, and this is showing in the price indexes for new homes, where first Toronto and then Vancouver have slowed drastically and dragged the national price index down with them.
Tight demand relative to supply for condo units is only the start of the story.
Why is there a tight supply for condos?
In Toronto and Vancouver, smaller condos have a more advantageous and profitable use. As a landlord, rent is easier to garnish and tenants are willing to pay more. Single family townhouses in Toronto are also popular as more are for rent than for sale.
What's the outlook?
Bank of Canada will continue to tighten short-term interest rates from now until 2020 and they will do this to head off inflation while also sustaining the value of our Dollar. This tightening will make mortgage interest rates rise, and based on Moody's Analytics, interest rates will be 6% by late 2020.
If you need to refinance large unsecured debt or are planning to move lenders to obtain a better rate, declining house prices will affect your ability to do so based on a max lending amount of 80% loan to value and the ability to qualify.
Understanding the risks of rising interest rates are imperative to weathering the storm in a higher interest rate environment. Speak to me today about steps you can take to save more money in the long term while avoiding payment shock.
Want to know what you should do? Have looming debt you would like to consolidate? Needing to find a way into the real estate market?
Call my office today for a private consultation.
Mortgage Agent Lic. M14000929
By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929