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Report on Business Paying for the reno: line of credit or renegotiate your mortgage?

According to CIBC poll results tabulated in the spring, 45 per cent of Canadians said they planned to renovate their home in 2018, either by making repairs or improvements. Of those, 59 per cent said they planned to dip into cash or savings to fund their projects. But nearly a third expected to cover the cost with a loan, credit cards or home equity line of credit (HELOC), particularly for full-scale renovations.

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The last cabinet door pulls are installed and the final lick of paint is on the wall. Now it’s just time to figure out exactly how you will pay for your home’s swishy new renovation.

It is a decision many Canadians are facing this year. According to CIBC poll results tabulated in the spring, 45 per cent of Canadians said they planned to renovate their home in 2018, either by making repairs or improvements. Of those, 59 per cent said they planned to dip into cash or savings to fund their projects. But nearly a third expected to cover the cost with a loan, credit cards or home equity line of credit (HELOC), particularly for full-scale renovations.

A HELOC is a revolving line of credit that allows a homeowner to borrow equity from their home at a lower rate than a regular unsecured line of credit (LOC) or loan. Think 4.20 per cent interest versus 6.35 per cent. It can be a good option for bankrolling big renovations that will likely take months versus weeks to complete says Robert McLister, founder of mortgage comparison site, RateSpy.com.

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“With most construction projects, there are draws,” he says, referring to times when people borrow a certain amount off their HELOC. Usually, homeowners will pay the trades in sequence as they finish their jobs: The people who put up drywall get paid before the flooring installers and the kitchen cabinet workers get paid before the painter, who usually swoops in at the tail end of the project.

“You borrow as needed to complete a project and you’re only paying interest on the money you take out at that time,” he says, comparing it to a refinanced mortgage that spreads out principal and interest payments over the course of the entire job.

A mortgage might give you a lower interest rate than a HELOC, but if you borrow only a small portion of the funds available at the beginning of the project, that higher line-of-credit rate will not apply to the rest. The remainder of the available funds cost nothing until they are needed. There is no set schedule for payment and most require only that the interest gets paid off each month.

The downside, of course, is that the homeowner is holding onto a lot of debt with a higher interest rate in comparison to the average mortgage. For instance, you might pay 3.55 per cent for a three-year fixed mortgage compared with 4.20-per-cent interest for a HELOC. A fraction of a percentage point might not seem like much now, but over the course of years, it can equal thousands of dollars in the bank.

The obvious solution is to roll the HELOC and any other debt accrued into a new, refinanced mortgage once the home is finished. But what is the best way to ensure you get the best deal for that new mortgage?

The first question you have to ask yourself is whether it makes sense to switch to a mortgage right away in the first place, says Mr. McLister. For a HELOC, you are only required to pay the interest each month. But for a mortgage, it is interest plus principal. So if you borrow $100,000 at today’s typical rates, expect to pay $347 a month (prime plus 0.50-per-cent interest) on your HELOC and $444 (3.44-per-cent interest with a 30-year amortization) on a mortgage.

“A lot of people want to minimize their payments so they can buy more stuff for their house or because they have debt obligations,” he says, mentioning that for someone unemployed or cash strapped for a while, lower payments look tempting.

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But keeping a balance rolling on a higher-interest HELOC is not a good idea long-term, says Mr. McLister. If you plan to have the debt for more than a year, it makes more sense to re-mortgage it at the best possible rate, he maintains.

To negotiate the best deal, it is important to understand what the total cost of borrowing is, says Chantel Chapman, a former mortgage broker and founder of Vancouver-based financial literacy organization, What The Finances.

In other words, don’t just focus on the actual interest rate percentage. Calculate everything, including home assessment fees and any penalties for shutting down an older mortgage that may already exist on the property. In some cases, a financial institution or broker might offer to refinance your first mortgage and combine it with the new one. You might be required to pay a penalty, but because the overall rate is better, you would still come out ahead.

In another scenario, your HELOC and old mortgage are blended and your final rate will be a little higher, but you would pay no penalty, she says.

No matter what kind of deal you are offered, run the numbers and keep your eyes on the results, rather than focus on the interest rate you’re given, she adds.

“We don’t have that emotional connection to the percentage as much as we do seeing the actual dollar amount,” says Ms. Chapman, pointing out that the difference between, say, 2.5 per cent and 4 per cent might not seem like much, but may eventually mean the difference between $30,000 in interest versus $50,000 in interest over five years. Thinking that way can help you decide which option is best.

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The bottom line is to always look at all the options before deciding. And if you aren’t comfortable running the calculations yourself, talk to a financial planner or get a second opinion from a broker.

“You should always shop around,” advises Ms. Chapman, mentioning that the internet is full of data to help borrowers become informed consumers. After all, when paying off an expensive home renovation, there is a lot of money on the line. “We’re not talking about, ‘Am I going to pay $180 for this vacuum or $190?’ We’re talking about thousands of dollars?”

There is no reason to feel too guilty walking away from your lender after he or she has spent so much time with you in the past months or year setting up the HELOC and other credit options to fund the reno, she says. Keep your eye on the money you will save on the mortgage. Besides, there ways to part amicably.

During her days as a broker, Ms. Chapman remembers a couple who found a better mortgage deal and eventually went elsewhere.

“They felt bad because they saw the amount of work that I did,” she says now. “So they sent me a gift card to go out for dinner.”

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