The newest product offering in convenient, low-cost borrowing has quite the hook.
Readvanceable mortgages combine a mortgage and home-equity line of credit (HELOC). As you pay down your mortgage, you increase the amount you can borrow. If you foresee mismanaging your finances so that you need ever-increasing amounts of borrowing room, then get one for sure. Avoid them if you want to maintain your financial independence and contain your ability to borrow.
The federal Financial Consumer Agency of Canada (FCAC) highlighted readvanceable mortgages in a warning issued Wednesday about the dangers of home-equity lines of credit. There are about three million HELOC accounts in Canada, with an average outstanding balance of $70,000.
Last year, roughly 80 per cent of HELOCs were in readvanceable mortgages.
In fact, banks have reported to the FCAC that the readvanceable mortgage is now the default option offered to people who have a good credit rating and are buying a home with a down payment of at least 20 per cent. You may be told about other mortgage choices in a bank branch, but expect the readvanceable option to be pushed on you.
Banks like readvanceable mortgages because they hook clients like fish. If you wanted to move your mortgage to another lender at some point, you'd have to pay upward of $1,000 in legal and discharge fees.
If you stay with your lender, prepare for some frustration when you discuss rates on renewing your mortgage. "The banks know the readvanceable mortgage is a sticky product," said Robert McLister, a mortgage planner and founder of RateSpy.com. "So you're generally not going to get offered the lowest mortgage rates on renewal."
For sure, there are some advantages to readvanceable mortgages. If you decide to add a HELOC to your traditional mortgage later on, expect to pay several hundred dollars in legal/setup fees. There are no additional costs for the HELOC component of a readvanceable mortgage, Mr. McLister said.
Also, a regular HELOC lets you access just 65 per cent of your property's value (your HELOC plus mortgage cannot be more than 80 per cent of your home's value). With a readvanceable mortgage, the full amount you borrow is available to you if you pay as agreed. When you pay down the principal, your available credit in the revolving portion grows equivalently.
A disciplined, savvy borrower could profit from this arrangement by investing money drawn from a HELOC to generate returns in excess of what the credit line costs. Rates for HELOCs these days are typically prime plus 0.5 of a percentage point, or 3.2 per cent at most banks. It's quite possible to earn higher returns than this by investing in stocks, for example.
The FCAC's concern is that HELOCs may be adding stress to the finances of Canadians at a time when their debt levels are already at a record high. The agency's stats on HELOCs do suggest people aren't managing them well. Most people don't pay their HELOCs in full until they sell their house, and 25 per cent pay only the interest or minimum amount every month. Forty per cent do not make regular payments toward the principal.
HELOCs can make sense as a financial tool for low-cost, short-term financing, but you have to keep them on a short leash. Get one after you've owned a house for several years and learned to manage your finances. Ask to have it added to your mortgage and be prepared to pay several hundred dollars in setup fees.
Once you have a HELOC added to your mortgage, you're in the same position as the person with the readvanceable mortgage in that you can't change lenders without racking up legal fees. But if you waited five years after buying to set up a HELOC, at least you get one mortgage renewal in before you lose your freedom to find a new lender.
The FCAC calls readvanceable mortgages inherently risky and complex products. The agency wants to develop guidance on better disclosure of these mortgages so that people can make more informed comparisons with traditional mortgages.
Until this better guidance comes along, be wary of readvanceable mortgages. They benefit banks at the expense of borrowers.