JM, from Edmonton, sent the following question:
Home-buying season is upon us, and I have a few questions. How are interest costs calculated (i.e. mortgage vs. secured line of credit)?
I am going to need some bridge financing; do you have any idea what sort of rates there are for this? Is there anything special about bridge financing, or is it just like any other loan?
I’ll tackle the difference between a mortgage and secured line of credit (SLOC) first. In a typical mortgage, every payment has two components: interest and principal. The principal payment reduces your mortgage balance and over time the portion of your payment that goes toward the interest decreases. A mortgage will typically have pre-payment privileges but you won’t be able to pay off the entire loan without incurring penalties. A SLOC is just a loan, typically at the prevailing prime rate, secured by your home. You only have to pay the monthly interest on the loan but you can choose to pay off the principal, in part or in full at any time. If you choose a variable rate mortgage, you will get usually get a discount off the prime rate but a SLOC is almost always at prime.
I haven’t personally done a bridge financing, so I am sure of the implications of taking a loan from the LOC secured by the old house. I would definitely suggest that you talk to your local bank to see what options you have. If you have enough equity in the old house for a down payment on the new one, you should be able to arrange a bridge financing. Our readers might have opinions, comments or suggestions on your question.
Bookmark: del.icio.us Digg StumbleUpon
17 responses so far ↓
1 RichardM // Apr 5, 2007 at 12:56 am
If by bridge financing you mean you will take posession of a new house before the sale of and old one closes, then it is a painless process. Just let your mortgage specialist know. They’ll pay off the balance of your existing mtg and advance the cash for your new one. It’s helpful if you are dealing with the same bank on both ends though - they hold the mtg on the old house and will hold it on the new. The rates are generally prime + 1% and it works like any other loan. Check and double check with your bank that everything is ok (they are aware that bridge financing is being used) about a week prior to taking possession of the new house - speaking from experience here
2 brad // Apr 5, 2007 at 7:19 am
As a first-time homebuyer, I am wondering whether a SLOC would make more sense for me than a mortgage. I’m fortunate enough to have, for now at least, a salary that’s high enough for me to be able to pay off a $300K loan in about 8 years, even while maxing out my annual RRSP contributions. I’d like to be able to do that, mainly because I’m burning out and don’t want to stay in my line of work forever, and any career change would almost certainly involve a huge pay cut. Owning my home would allow me to feel more comfortable taking the risk of moving on to a job that I enjoy more but that pays less.
However, I hate paying interest to banks, so the the lower interest on a mortgage (compared with SLOC) is attractive, plus I could put my “extra” money into investments instead of throwing it all at my mortgage or SLOC. ING offers a mortgage that allows you to pay up to 25% extra each month as well as a lump-sum additional payment of up to 25% each year.
I’m torn about what to do (and am not even sure SLOC is available to first-time homebuyers). Any suggestions?
3 0xcc // Apr 5, 2007 at 8:23 am
Brad, what sort of downpayment (in terms of %) are you looking at being able to put down. Typically SLOCs are only available on 75% of the value of the property. That doesn’t mean you can’t get a ‘regular’ mortgage for the difference between your down payment and 25%. There are a lot of options available and a mortgage specialist should be able to guide you through the options and get you what you want.
As for whether you should go for a SLOC at all, that is a really personal decision. Are you comfortable with your minimum monthly payment changing along with interest rates? Will you be able to pay just the minimum or do you plan on paying 10%, 20%, 30% more than that? Do you think that interest rates are going to go up or down? Would you be comfortable if you guessed wrong on the direction of interest rates? There are a lot of factors that make up the decision to go to a SLOC and everyone has different reasons for choosing which way to go.
4 sarah // Apr 5, 2007 at 8:29 am
Brad,
My husband and I got a HELOC (home equity line of credit) with TD as first time homebuyers. The only requirement is a 25% downpayment. We had the option of locking in any portion as a term mortgage inside of the HELOC (it came with mortgage rates, terms and conditions).
If you can carry the payments and wish to pay down your loan rapidly, simply choose a shorter amortization period (the time it takes to pay off the loan). The standard is 25 years, but 10 years might be more appropriate for you. This is separate from the term of the loan (the period over which you fix the payments). The most common term for a fixed rate loan is 5 years, although it can range from 6 months to about 10 years.
Of course, depending on the interest rate, your investing style and market performance, it could be better for you to invest your additional funds rather than pay down your mortgage. When you are ready to leave your stressful job, you could either pay off your mortgage or simply make your payments from your investment accounts. This decision has many important factors to consider - your cash flow, your comfort level with risk, your tax bracket, and whether or not you plan to stay in the house and your ability to continue working should the market underperform.
5 Mike // Apr 5, 2007 at 8:46 am
Not sure if we’re talking about the same thing but I have a HELOC from TD as well - it doesn’t have to float with prime - I can lock it in for 1,2,n years at competitive rates just like a mortgage. I found it pretty useful over the last couple of years but I might give it up because I want to get the best rate I can in July when I renew. I’ve found the line of credit can be a bad thing too, since you have very easy access to cheap credit.
6 brad // Apr 5, 2007 at 9:05 am
Thanks everyone, this is helpful. FYI, I’m planning on having $100K as a downpayment (almost there, will have the rest of it saved up in five or six months), which would allow me to have a 25 percent downpayment for any house we like up to $400K, which is about as high as I’m comfortable going anyway. I want to have at least 25% down anyway in order to avoid mortgage insurance.
7 Dan // Apr 5, 2007 at 10:21 am
Brad: I would be very surprised that you could get a SLOC to buy the house. A SLOC is a 2nd mortgage (flexable, but still a mortgage). Get a mortgage that is a true bi-weekly payment, lower the amortization period to 10 or 12 yrs, be allowed to increase the amount of your payments by at least 10$.
dan
8 Canadian Capitalist // Apr 5, 2007 at 10:28 am
Sarah: Is the TD HELOC at prime?
Brad: A traditional mortgage should give you the flexibility you are looking for. Our mortgage, for instance, has a 20% annual and a 20% extra monthly payment privilege. That’s more than enough to pay off a mortgage in 8 years.
9 Canadian Capitalist // Apr 5, 2007 at 10:43 am
Richard: I think JM wants to know how to pull off buying a new house before the old one is sold. I think your tip is what he was looking for. Thanks.
10 Steve Heath // Apr 5, 2007 at 10:47 am
Brad, I echo the others with getting a mortgage and dropping down the amortization period. On top of that, you will usually be able to do an extra 15% of the original mortgage amount as extra payments, which would let you drop up to another $45,000 / year on a $300,000 mortgage, which should give you more than enough room to accommodate any extra payments you would want to put on, negating the benefit of the LOC, leaving the lower interest rate on the mortgage as the key difference.
11 Bryce // Apr 5, 2007 at 11:46 am
Brad,
It doesn’t sound like you are going to be affected to much by changing interest rates so why not just go for a variable open mortgage and then you can pay what ever you want on it. I have a 3 year open that is at prime-0.85 from BMO. I don’t know it they still have that one or not. Any principal that I pay over and above amortization period is still accessable to me. You just can’t go deeper.
12 Jennie // Apr 5, 2007 at 12:58 pm
TD HELOC (Home Equity Line of Credit) is at prime, 6% currently. Unless you (like Brad) like to have flexibility on draw down, the rate on TD variable rate mortgage is much better, at Prime minus 75bps or even 90bps depending on the negotiation skills.
13 Nord64 // Apr 5, 2007 at 1:15 pm
Just on a side note, a good friend of mine tried last year to get bridge financing for his new house because the old one was not selling in time. Several banks would not give him bridge financing, unless the old house had be firmly sold. In the end he made it because the old house sold and closes within 4 weeks
14 sarah // Apr 5, 2007 at 1:52 pm
Canadian Capitalist:
The revolving part of the HELOC is at prime.
You can choose, however, to lock in any portion of the HELOC as a mortgage.
Ex:
300k mortgage
Lien on house: 300k
sub accounts:
Revolving:
100k
Prime rate
Minimum payment: Interest only
Maximum payment: None
Fixed:
100k
5.38% Fixed Closed, 5 year term, 15 year amortization
Minimum payment: Principle + Interest
Maximum payment: 2x minimum payment every payment + 15% of original balance per year
(Please note: The following section is from what I understood from our mortgage specialist - we have a 5 year closed fixed rate but I’m pretty sure that you can choose a to wrap a variable rate mortgage inside of your HELOC too).
100k
Prime -.5% variable rate mortgage, 5 year term, 15 year amortization
Minimum payment: Principle + Interest
Maximum payment: 2x minimum payment every payment + 15% of original balance per year
You can have, at any time, a maximum of 300k owing. Any amount you pay down on the fixed portion can be reborrowed from the revolving portion at any time.
15 Rob // Apr 7, 2007 at 10:04 am
My quick comment on bridge financing: Refuse to pay the fee for the bridge. Banks will charge you a per-day interest rate (which is certainly fair since you’re using their money), but they also will often tack on a fee for the bridge service, often to the tune of $250 or $500.
If the bank is getting your mortgage business, they don’t need to charge you a fee for the entire transaction to be profitable for them… so refuse to pay it. For clarity, pay the interest, but refuse to the pay the fee.
Obviously, you need to arrange this prior to the closing dates, and you will enjoy the most success when you have a competing bank’s offer to waive the fee. If the bank believes you are ready to switch over the issue, they will not let the business walk out the door. Negotiate this point last, after all rates are worked out and in writing.
I have a 100% rate negotiating this for my clients, and I am sure that, done as described, Canadian Capitalist readers will enjoy equal success.
16 JM // Apr 10, 2007 at 1:02 am
Thanks for the comments. Your comments answered my questions, and many more.
CC - you have a great/helpful blog
17 Vic Perroni // Nov 11, 2007 at 5:08 pm
I am highly interested in obtaining commercial bridge financing , 6 to 12 months …
It is a big problem here in Canada !
Anyone can contact Me at my email vicp@rogers.com
Leave a Comment