globeinvestor.com

News from The Globe and Mail

Rob Carrick

Saturday, November 23, 2002

The recent news on house prices adds a whole new dimension to the old expression "home sweet home."

Average prices in major markets across the country were up about 10 per cent through the first 10 months of the year, and the accumulative gains over the past few years in some cities ranged from 15 to 35 per cent. These are dazzling numbers, but you might wonder how relevant they are if you have no intention of selling your home.

But do you plan to borrow in the near future, say for a home renovation, a trip, a car or to invest for yourself or your children's university education? If so, then the increase in the value of your home is directly relevant to you.

The absolute cheapest way to borrow is to use debt secured by the value of your home. The more equity you have in your home, the more you can borrow.

If you have a mortgage, you might be surprised to see how much equity you've built up in your home thanks to a combination of making regular payments and rising house prices.

It's easily possible that your equity has doubled if you bought a home a few years ago, especially if you made only a small down payment.

There are a couple of different ways to exploit a paper gain in the value of your house from a borrowing point of view. You can set up a home equity line of credit that will be available whenever you want, or you can refinance your mortgage to add on new debt. Some lenders, including Bank of Nova Scotia and TD Canada Trust, now offer innovative home equity products that let you combine both types of borrowing.

No matter what type of debt you take on, the fact that your home is collateral for the loan, ensures you'll get a better interest rate than you would with a so-called unsecured line of credit or loan.

The rate for a secured line of credit should absolutely be at prime, now 4.5 per cent, if you have a sterling credit rating, though some lenders may want to pad the rate by a percentage point or two. If you go the refinancing route, you can probably secure mortgage rates as low as 4 to 6 per cent, depending on the term and type of mortgage. (Rates for refinancings are fully negotiable.)

By comparison, an unsecured credit line might typically cost 6 per cent to 8.75 per cent right now, while an unsecured consumer loan might be in the range of 7.5 to 12 per cent.

Borrowing against home equity is one of the hottest niches in banking these days. Banks, credit unions and trust companies have been simplifying things for customers who want to pay down their mortgages, and now they're making it easy to run that debt back up again.

Well, sort of easy. There are actually quite a few hidden complexities to this type of borrowing that can create nasty last-minute surprises for the unprepared. Here, then, are the basics of home equity borrowing.

Are you eligible? Generally, you can borrow up to 75 per cent of your home's value, minus any outstanding principal (see chart).

It is possible to borrow up to 90 per cent of your home's value, but you'll have to pay mortgage insurance premiums that could range as high as 2 or 3 per cent of your principal. Obviously, these premiums will work against the low-rate benefit of borrowing against your home equity.

Consider the up-front costs. Legal fees will apply whether you're setting up a home equity line of credit or a mortgage refinancing. According to Scotiabank, costs could range from about $229 or so in Alberta and Saskatchewan to $449 in Ontario and $550 in Quebec.

Your lender may also ask for an appraisal, possibly to document that your home is worth much more than you paid, and that your equity has in fact ballooned. This could cost in the area of $165 to $250, Scotiabank says.

Worst case, you'll have to pay these expenses out of pocket. Best case, you negotiate a deal where your lender foots the bill.

Note also that some lenders will absorb fees as part of periodic promotions -- be sure to ask about this. Note that Canadian Imperial Bank of Commerce has a deal on until Dec. 31 where it will cover these costs. CIBC will also cover the cost of an appraisal, if one is required.

Royal Bank of Canada has an offer on now where it pays legal and appraisal fees for secured credit lines of $50,000 or more.

What type of borrowing should you use? Mortgage refinancings are ideal for major expenditures such as home renovations, where you want to make regular payments over a longer period of time to repay the debt. A line of credit works well for debts that you'll be able to pay back in reasonably short order.

Think of a line of credit as a contingency fund you can dip into whenever the need arises (usually through special cheques or withdrawals from bank machines). Note that credit lines don't have set repayment schedules like mortgages, but you do have to make minimum payments each month.

You can also pay them off whenever you want without penalty, unlike most mortgages.

Refinancing your mortgage can make the payments for large debts more manageable, and you may get a better interest rate than with a credit line. On the other hand, you'll likely amortize the mortgage over a period of many years and thus drive up your overall interest costs.

If you're interested in a mortgage refinancing, the simplest way to do it is when you renew your existing mortgage. Your new principal will be added to the mortgage and off you go.

Should you want to refinance in the middle of a mortgage term, be sure to ask whether your lender will charge you a penalty. Refinancing a mortgage can be interpreted as breaking a mortgage, which means a charge may be applied by the lender.

Some banks, Bank of Montreal and Royal Bank of Canada for example, will allow you to blend your current mortgage with your new principal as long as you keep the remaining term on the existing mortgage or extend it.

If there is a penalty, your lender may factor it into the rate on the renegotiated mortgage rather than charge it to you up-front.

A lot of home equity borrowing these days is being done as part of a debt consolidation plan that might, for example, bring together a mortgage, a credit card debt and a car loan.

The benefits here are obvious -- credit card interest rates are in the range of 18 per cent, while car loans can be as high as 7 to 11 per cent. There's a huge potential drawback here, though.

The longer you take to repay your consolidated debts, the more you allow the benefit of your low home equity interest rate to erode. Generally, long repayment periods may be fine for a renovation that adds value to your home, but not for debts acquired from vacations, clothing purchases or other transitory things.

To get around a potential interest sink hole like this, plan to pay down your debt as quickly as possible by making extra payments or a lump-sum payment.

If borrowing against your home equity doesn't work for you, it's possible to get unsecured credit lines as low as 6.2 per cent from alternative banks ING Direct and President's Choice Financial.

For the cheapest borrowing costs, though, there's no place like home.

Next week: A look at some of the more interesting bank home equity borrowing products.

THE COMPARATIVE COSTS OF BORROWING

Rising house prices mean Canadians may have a lot more equity in their homes than they did even a few years ago. With rising equity comes increased borrowing power. Here's how it works.

Rising equity

2000

Value of home: $225,000

Equity in home: 15% or $33,750

October, 2002

Value of home: $270,000

Equity in home: 33.6% or $90,750*

*Rise in equity comes from lowering principal by $12,000 through mortgage payments, but mostly through rising home values.

Typical bank line of credit, 7%

Amount borrowed: ............$23,250

Cost (interest) for one year....$891

Home equity line of credit, 4.5% (prime)

With an appraaised home value of $270,000, you can now borrow:

75% x $270,000......................$202,500

Less outstanding mortgage balance...$179,250

Borrowing power......................$23,250

Amount borrowed: ....................$23,250

Cost (interest) for one year............$571

SOURCE: INFORMATION RESEARCH

© The Globe and Mail