Most people would love to pay down their mortgage quicker if they could.
Making pre-payments generates one of the best returns on your money, for two reasons:
- There’s no risk
- You’re guaranteed a return without losing your principal.
- Taxes are due on interest you earn, not on interest you save
- As a result, the effective after-tax rate of return on a mortgage pre-payment is pretty decent.
- Example: Pre-paying a 3.99% mortgage in a 40% tax bracket is like earning 6.65%, risk-free.
Yet, many people won’t use their spare cash to pre-pay their mortgage, for fear they might need that money down the road.
That’s supported by a recent Manulife Bank survey that suggests nearly half of Canadians would consider pre-paying their mortgage if they could “easily access that money again, should their needs change.”
One way to do that, of course, is with a readvanceable mortgage. A readvanceable lets you re-borrow paid-down principal any time you need it, up to your approved limit.
In a readvanceable, your “limit” is the total borrowing your lender approves you for, including both your mortgage and line of credit.
Readvanceables are available to well-qualified borrowers who have at least 20% equity in their home. If you can get a readvanceable for a similar rate as a regular mortgage, it’s worth considering. Having the benefit of liquidity can be priceless if a need arises later for low-cost funds.
Just remember two things if you’re considering a readvanceable:
- Readvanceable mortgages make it easy to spend, so be sure you’re disciplined enough not to blow the line of credit on discretionary spending.
- If you move a readvanceable mortgage to a new lender at maturity the mortgage must be re-registered. That means you’ll often need to pay a lawyer—whereas a regular mortgage can be switched without legal fees.
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Sidebar: The Manulife Bank survey had a few more notable findings:
- 64% of respondents did not make any mortgage pre-payments in the past year
- 43% said they’d have difficulty making their regular mortgage payment within three months, if the primary income earner lost their job. Of these, 17 per cent would have difficulty after one month.
- 40% could keep up their mortgage payments for 3-12 months if the primary income earner lost their job.
Last modified: April 26, 2014
What kind of premium do you generally pay switching from a variable or fixed over to a similar readvanceable?
Hi Traciatim,
The readvanceable rate may be lower, higher, or the same as a regular mortgage. It depends on the term you want and the promotions available. In cases where the rate is higher, it’s typically no more than 5-15 basis points higher.
Cheers,
Rob
I have two re-advanceable mortgages. One on my principal residence and one on my rental property. I strongly recommend this type of product. I invest my mortgage principal as it becomes available in my LOC and deduct the interest expense used to earn the investment income. The only quirk is that the LOC portion of your mortgage gets reported to the credit bureau (at least through RBC) so it really kills your credit score if you’re fully utilizing the credit line for investment purposes.
Hi Shannon,
Thanks for the post. You make an excellent point about the impact of maxed credit lines on your credit score. Here’s a piece we did on that a while back: HELOCs & Credit Scores
Cheers,
Rob
> 40% could keep up their mortgage payments
I wonder how many would need to use credit cards or a heloc to keep making the payments
What about using the Smith Manoever to pay down your mortgage debt?
SB
Hi SB, The Smith Manoeuvre (or a variant) is indeed an option for the right kind of homeowner with a long-term investor mentality. It’s not everyone’s cup of tea though, and there is risk. A chat with one’s investment advisor is always wise before leveraging to invest. Cheers, – Rob
what other variations are there besides SM that may be less riskier ?
SB