Why the Five-year Fixed-rate Mortgage is OverratedApril 8, 2010
The Ten-year Fixed-rate Mortgage: A Contrarian’s Point of ViewApril 12, 2010
If you surveyed people who work inside the mortgage industry, I am confident you would find that the majority of those insiders who qualify have readvanceable mortgages.
These killer products give borrowers who have at least 20% equity in their property the ability to customize their loan by allocating it between a mortgage (fixed or variable) and a secured line of credit. The mortgage terms can be fixed for anywhere from two to ten years and the line of credit typically floats at prime 0.50% and can be paid down or readvanced at any time with no penalty. In terms of flexibility, there is no better product.
Here is an example:
Assume that you need a mortgage for $300,000, that the ten-year fixed rate is available at 5.3%, and that the floating line-of-credit rate is at prime plus .50% (which we’ll assume is equal to 3.25% in this example).
You decide how the overall loan should be allocated between the mortgage and the line of credit. As we extend the example, let’s assume that while you’re very conservative overall, you still want to enjoy some of the floating-rate savings currently available by allocating a portion of your loan to a line of credit.
Assume you choose a $220,000 fixed-rate mortgage, with $80,000 as your floating-rate line-of-credit portion.
Your overall rate would be 4.75% and most of your loan would be locked in for ten years, giving you solid interest-rate protection. A smaller portion would be saving you money in the short term and giving you lots of flexibility over the long term. With the best readvanceables, as you pay down your mortgage, an additional benefit accrues because your line of credit increases as you pay down principal, allowing you to reborrow back to your original loan amount at any time. This feature helps address real estate’s biggest weakness: illiquidity.
Using the example above, after five years, the fixed portion of the loan is reduced from $220,000 to $195,622 (assuming a 25-year amortization). That $24,378 of paid-down principal is automatically added to your line-of-credit limit, increasing it from $80,000 to $104,378, which can be reborrowed at any time at no additional cost.
This means that instead of keeping $5,000 in an emergency bank account earning a lousy rate of return, you can use it to pay down your line of credit, safe in the knowledge that you can have it back if and when you want it.
Don’t have enough cash in your account to cover your credit card balance this month? Would you rather pay your credit card company 19% to roll the balance or write a cheque using your secured line of credit and pay 3.25% instead?
As you build up more equity, you can use your line of credit for investments, which if you comply with CRA’s eligibility rules, makes the interest charged on that portion tax deductable.
The bottom line is that flexibility gives you options, and when you want to borrow, mortgage loans on primary residences offer the lowest personal rates available. Your readvanceable mortgage effectively acts as a one-stop debt management tool for all your borrowing needs. Sure beats the boring old plain-vanilla five-year fixed mortgage in my books.
Interested? Not all lenders offer the same features for readvanceable mortgages so be sure to consult an independent mortgage broker to learn which lender’s product fits best with your specific profile.