Paying off one debt to take on another

Bruce Sellery says there are times when it makes sense to add to your mortgage, especially if it helps you avoid taking on more expensive debt.

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Question

My wife and I will become mortgage-free in October 2014. We’re looking to replace our deck in 2013 and our vehicles in 2014. We both have lines of credit, but we wonder if using a home equity line of credit (HELOC) to fund these expenses is a better idea as the interest rates are generally lower. What do you think?

Answer

Mortgage-free is an enviable moniker that takes decades to earn. And for you, it is almost within reach. You won’t be able to brag about it at a cocktail party like you could a PhD, but you can smile inconspicuously while the rest of the guests rage about being house poor.

That is, if you are indeed mortgage free in 2014. I don’t mean to burst your bubble, but you might want to put off your big celebration a little longer because a mortgage might be the cheapest way to finance this new debt.

A traditional mortgage is cheaper than a HELOC

A HELOC carries a lower interest rate than a traditional line of credit (LOC), for the simple fact that it is secured again the value of your home. The lender has confidence that you’ll pay them, because if you don’t they’ll change the locks on your doors. But even cheaper than both the HELOC and the LOC is, wait for it, a boring old mortgage.

“In most circumstances, the traditional mortgage is the least expensive: rates are lower by 0.50% to 1%, compared to the HELOC and by 3% to 5% compared to the unsecured line of credit, says Joe Jacobs is a mortgage broker with Mortgage Connections in Calgary. “It may make more sense to refinance and put on a mortgage and then use the monies for the deck and vehicles, as opposed to setting up a HELOC.”

Mortgages provide more rate certainly than a line of credit

The other thing to keep in mind is that a fixed rate mortgage has a rate that is guaranteed for the term. And even a variable mortgage has a rate that is fixed to prime. If you have a line of credit, the lender may be able to change the rate with 30 days notice. If you go that route, it will be important for you to understand how that part of the contract works.

How much do you need and for how long?

From an interest rate perspective, a traditional mortgage will allow you to borrow at the lowest cost. But that plan makes less sense if the loan value is low and the duration is short. Say you only need $10,000 and can pay it back in under a year. In that case a HELOC might be best because it gives you flexibility. But for two cars and a deck, my hunch is that the amount you need is going to be much higher than that.

That said if you think you might have a little extra cash kicking around then that’s when a HELOC or a LOC make more sense. Unlike a mortgage, these types of loans tend to offer more flexible repayment terms that allow you to chip away at the loan without having to worry about early repayment penalties.

Get the numbers crunched

I gave you a big picture answer. I recommend you talk to a mortgage specialist and ask them to give you a more detailed answer by laying out a few specific scenarios based on real numbers. You’ll need to estimate the cost of the deck and the new vehicles and how quickly you could afford to pay the debt back.

By the sounds of things, you will reach the Mortgage Free finish line very soon, but perhaps just not as soon as you’d have liked.

ask@moneysense.ca

3 comments on “Paying off one debt to take on another

  1. Or… this may sound a bit crazy, but how about saving up for the purchases! It's a little old fashioned, but it will save them at least 2%.

    Reply

    • What a vintage idea. Bring back the LAY AWAY! I agree with you. Saving up for purchases is a skill needs a rejuvenation.

      Reply

  2. Hello Bruce,
    Our mortgage is up for renewal this Sept 2012. We have a mortgage of $75000.00 and a HELOC of $101000.00. Should we combine these into a mortgage? We are not sure what would be better to save on interest long term. Would you suggest using a Mortgage Broker? We have always trusted our Bank in the past to give us sound advice? I look forward to your great advice
    Thank you in advance
    L

    Reply

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