By definition, the word mortgage comes from the French word “mort” which means “dead” and “gage” from Old English, which means “pledge”. It is a conveyance of an interest in property as security for the repayment of money borrowed. A traditional mortgage will have both principal and interest payments to eventually pay off the debt over a period of time (referred to as the amortization period).
A HELOC (Home Equity Line Of Credit) is a form of revolving credit in which your home serves as collateral. With a home equity line, you will be approved for a specific amount of credit. The maximum limit is determined by your debt servicing ability and the appraised value of your home (maximum 80% loan to value). As an example, if your home was appraised for $400,000 then the maximum limit that can be approved would be $320,000 (assuming of course that debt servicing was within the lender’s guidelines). You are required to pay interest only monthly payments as there is no obligation to pay down any principal.
In both cases you have pledged your home as security and in the event of any serious delinquency, the lender could exercise their right to foreclose. I’ve had clients often mention that they do not have a mortgage on their residence (they consider themselves “mortgage free”), but quickly add that they have a HELOC instead. Their HELOC may have a current balance of $300,000 and has been at that balance for years paying only the required monthly interest. Most clients find it difficult to pay down any principal as there is always unexpected expenses throughout the year, never mind occasional interruptions in their income.
One disadvantage with a HELOC is that the interest rate that the lenders charge is normally higher than a VRM (variable rate mortgage). This difference could be as high as 1% which is quite substantial in my opinion. Yes, a HELOC is open and there is no penalty if you were to sell your residence and pay off your loan completely. However, most clients do not intend to sell their home anytime soon, so the extra interest that is paid is hard to justify. Secondly, it may be difficult with your lender to lock in the majority of your HELOC to a fixed/variable rate product to secure lower rates and still keeping a portion available as a HELOC. So what do we suggest?
BOTH! We have lenders that will allow you the flexibility of a re-advanceable mortgage that includes a line of credit product along with your choice of fixed/variable rate products that can work well with your monthly budget requirements. Save on interest, have available cash when you need it, and reduce your principal all at the same time. Call me today for more details.
