Last week in Part 1 of this post I explained how borrowers who have built up at least 20% equity in their property can use extended amortization periods to enhance their mortgage’s flexibility with a technique I referred to as cash-flow buffering.
In today’s post I’ll outline a second tweak that gives conventional borrowers the ability to re-borrow up to 80% of the value of their home without having to break their existing mortgage or pay any penalties. As with the first tip, this tweak can be made at no additional cost, as long as you qualify.
Tweak #2: Add a HELOC and Choose An Automatically Readvanceable Mortgage
The term HELOC stands for home-equity line-of-credit. These are simply lines-of-credit that are secured against your home and are combined with traditional fixed- or variable-rate mortgages.
(Because they are secured, HELOCs come with much lower interest rates than are normally offered on unsecured lines-of-credit. For example, HELOCs are available today in the 3.5% range while unsecured lines-of-credit tend to be offered in the 5% range).
Let’s illustrate how HELOCs are set up with an example:
Assume that you decide to borrow $300,000 against a $500,000 property (which equates to 60% of its value). There are several lenders that will allow you to add a HELOC to your mortgage as long as the combination of your mortgage amount and the limit on your HELOC does not exceed 80% of the property’s value. Given that criterion, your maximum HELOC limit in this case is $100,000.
On the day of funding, the lender advances you $300,000 and you make a down payment of $200,000, just the same as you would if you took out a standard mortgage. Only now, behind your mortgage sits your HELOC and its $100,000 of additional borrowing capacity in case you ever need it.
This tweak alone will give you a powerful financial shock absorber that can help in any unforeseen circumstances but you can enhance your flexibility even further if you choose a lender that offers a HELOC in combination with an automatically readvanceable mortgage. (You have to know where to look for these because while many lenders offer HELOCs, only a few of them come with automatically readvanceable mortgages.)
If a mortgage is automatically readvanceable, every time you reduce your mortgage balance by one dollar your HELOC increases by the same amount. This means you can re-borrow all of your paid-down mortgage principle at any time without altering the existing terms of your loan (like your ultra-low interest rate) or incurring any penalties.
I love this feature because it virtually eliminates the need for you to keep rainy day funds sitting on the sidelines earning a paltry rate of interest while you pay a multiple of that rate in mortgage interest (in many cases, to the same institution!)
Now for the “catch” I referred to in Part 1 of this post. Our banking regulator (OSFI) has mandated that on November 1st, 2012, all federally regulated lenders must limit their HELOCs and readvanceable mortgages to 65% of a property’s value (although all existing loans of this type will be grandfathered). That means the HELOC window of opportunity is closing fast for conventional borrowers who have loans between 65% and 80% of the value of their homes.
To be clear, I understand why OSFI has decided to limit HELOCs and readvanceable mortgages. Marginal borrowers have used these products to live above their means and something had to be done to prevent them from undermining the stability of both our real estate markets and our overall financial system. But this necessary change will limit flexibility for many Canadian borrowers who use debt responsibly, and it is to that group that this post is aimed.
In today’s uncertain economic times I think it behooves every borrower to consider building themselves a mortgage bunker…while they still can.