Advertisement
A MoneySense reader wants to buy a second property, perhaps using the equity in her primary residence. What should she consider before setting up a HELOC?
I am considering taking out a HELOC loan to buy another property. Is this a wise decision, or would a loan be better? My bank advises me that I can qualify for a $400,000 HELOC.
–Caren
When buying a second property, Canadians can choose from a number of financing options, including a home equity line of credit (HELOC), a mortgage, or a personal loan. Before you decide, it’s a good idea to consider practical matters including interest rates, cash flow, income tax, and more. Let’s dive in.
When you borrow money using a HELOC secured by the value of your home, the interest rate is typically prime plus a small premium of 0.5% to 1%. Today, that would mean an interest rate between 5.45% and 5.95%.
By comparison, variable-rate mortgages are usually offered at a discount to prime of maybe 0.5% to 1%. The interest rates for fixed-rate mortgages are currently in that range, too.
As a result, Caren, there is the potential to save 1% to 2% interest with a mortgage on the new property instead of a HELOC on your existing property. That could mean saving thousands of dollars in interest per year.
Answer a few quick questions to get a personalized quote, whether you’re buying, renewing or refinancing.
For most lines of credit, you are only required to pay the interest on the loan each month. Principal payments may be optional for a so-called “interest-only” line of credit.
By comparison, a mortgage is amortized—meaning paid off in regular installments—over a number of years. This requires payments of interest as well as principal, so mortgage payments are higher than those for a line of credit.
So, the trade-off to have a lower interest rate is higher required monthly payments. Can your monthly cash flow comfortably accommodate that?
If you are purchasing this property with the intention of renting it out, Caren, there are tax considerations for your borrowing.
If you get a mortgage on the property to buy it, the interest will be deductible against the rental income, along with other eligible rental expenses.
There is a misconception about borrowing and rental properties that only interest on debt secured by the property itself is tax-deductible. It is actually the use of borrowed funds that determines tax deductibility. If you use a HELOC on your home to buy a property you plan to rent out, the interest on that borrowed HELOC balance is tax-deductible.
Extending this concept, if you borrowed against the rental property in the future—whether using a mortgage or a HELOC on it—that interest is not automatically tax-deductible. If the borrowed funds were used for a renovation on the rental, to buy another rental property, or for some other eligible business or investment purpose, the interest may then be tax-deductible. But if you borrowed the funds to purchase a car, the resulting interest would not be tax-deductible, despite being borrowed against a rental property.
If this second property is a personal-use property—like a cottage or ski chalet—the interest would not be tax-deductible unless you are also renting it out.
One reason to get a new mortgage on the property is to keep your finances separate. Some people would get stressed seeing a line-of-credit balance on their primary residence and would be better able to compartmentalize the debt if it were secured by the new property itself.
Thus, compartmentalization may have a psychological benefit by pairing the debt with the asset itself.
If your bank approved you for a $400,000 HELOC, Caren, that probably means it would approve you for more if you borrowed against the second property’s value.
The HELOC has limits based on your own property’s value, as well as your income. A mortgage on the new property could be higher, especially if there will be rental income, which would increase your total income-earning ability.
When buying a second property, how you use it will determine the tax implications for the borrowed funds, if any.
A mortgage will generally have a lower interest rate than a HELOC will, but mortgages also have higher monthly payments.
Your bank or mortgage broker can help you determine your borrowing capacity and explore financing options. And, as always, you should assess whether a second property purchase should be financed with savings instead of debt, and whether the new purchase makes sense from a big-picture financial-planning perspective.
Share this article Share on Facebook Share on Twitter Share on Linkedin Share on Reddit Share on Email
Bitcoin is the seventh-largest global asset—can it keep rising? Plus, ETH’s resurgence, and whether investing in MSTR is a...
It matters how you designate a spouse on your TFSA should you die before they do. Successor holders get...
Many people aren’t taking advantage of the tax credits and government benefits they’re eligible for. Jason Heath highlights four...
Created By
Ratehub
Investors are sometimes reluctant to sell a stock because the capital gains tax will be substantial. Here are some...
Young Canadians are building wealth by buying “boring” businesses from Boomers. Here’s why laundromats, trades, and car washes are...
A MoneySense reader asks what tax and probate implications she might face if she inherits a rental property held...
The co-founder of online prenuptial agreement startup Jointly talks about leaving Big Law, tracking spending as a system, and...
The Index Matrix vividly illustrates how different assets performed in the past. Here’s how Canadians can use it to...
A MoneySense reader wants to give money to his spouse to invest. Can he avoid Canada’s income attribution rules?