Credit line vs. mortgage – what makes the most sense? Often, clients ask us whether they should obtain a mortgage or credit line for their purchase, refinance or renewal. First, let’s qualify what we’re referring to with respect to a mortgage and a credit line. For our purposes, a mortgage is a standard debt instrument registered against a property. The payment is blended, implying that both principal and interest are paid in each instalment; furthermore, amortization periods currently go as high as 35 years and rates are based on prescribed terms (i.e., 1, 2, 3, 4, 5, 7, 10 yr). Standard mortgages are either fixed or variable/floating. Conversely, when we refer to a credit line, we’re specifically talking about a HELOC (home equity line of credit), which is secured by your property, NOT an unsecured line. Contrary to a standard mortgage, HELOCs are interest only, are not amortized, do not consist of terms and the rate floats according to the prevailing prime rate.
When a mortgage is better
A mortgage makes more sense when there is no immediate intent to repay the money. The majority of people purchasing a home will fall into this category. First, the rate will be lower than that of a secured credit line and you’ll have a choice of both fixed and variable terms. The reason for the lower rate is because standard mortgages carry a discharge penalty, whereas HELOCs do not. If you have no immediate plans to sell (and we’re talking very immediate), it makes no sense to take on an interest only product at a high rate. You’re not paying any of the principal down with each instalment, so you’ll end up owing the same amount as you started out with! Not having a penalty with a HELOC becomes a non-issue after several months as you’ll offset a standard mortgage penalty due to interest savings from the lower relative rate. Plus, if your circumstances happen to change during your mortgage term or you have some extra money kicking around, you can take advantage of conventional mortgage flexibilities without being penalized – i.e., pre-payments, porting to another property, etc.
When a HELOC (credit line) is better
A HELOC makes more sense when you require total flexibility to draw down a credit line (aka use it) and then pay it back right away – then repeat. This is suitable for someone who has constant short-term money requirements; particularly on the investment side of things (i.e., real estate, equities, bonds, etc.). The increased interest cost becomes irrelevant because of the inherent flexibility in a HELOC. You can always access the money after you’ve paid it off, over and over again. A standard mortgage doesn’t allow you to re-advance the funds. Once you’ve paid down/off the mortgage, the only way to access it again is by refinancing your mortgage. HOWEVER, BE CAREFUL! Banks love offering HELOCs to people, regardless of suitability, because it makes it harder to leave that bank in the future and it often enables people to get into more debt – we see this ALL the time.
Bottom line, the litmus test for deciding whether a mortgage or credit line is better for you comes down to the purpose and timing of the money. What are you using it for? How long are you planning to borrow it and when are you going to pay it back? When will you need it again? The most suitable option for the majority of people will inevitably be a standard mortgage.