What’s going on with your line of credit?
It is most likely rising, much to the chagrin of many Canadians who thought it would continue to track the Bank of Canada’s key benchmark rate, percentage point for point.
Edmonton machinist Neil Gordey found that out the hard way, when he got a notice last month that his line of credit was going from prime, up to prime plus one percentage point.
“Can they do this? After entering in to an agreement with them for a product at a decided rate, can they simply change the terms like they did?” asks Mr. Gordey, who had taken the remaining loan amount on his variable-rate mortgage and rolled it into a line of credit for better flexibility.
The answer to that is that it depends on your contract. But know this: The bank can change the rate and some have raised it on credit lines because their own cost of capital has gone up.
Some, such as the Canadian Imperial Bank of Commerce and the Bank of Montreal, have done just that. TD Canada Trust has chosen to “grandfather” customers whose rate was set before the credit crisis.
The good news is that with prime at 2.25%, customers with strong credit are still borrowing at 3.25% if their loan is secured by something such as a house. In the end, you might be better off because prime at most of the major banks was above 3.25% just seven months ago.
The outstanding loan amount on lines of credit has exploded over the past year, jumping by 20%. “I think consumers realize there is a deal out there that they might not be able to get later,” says Benjamin Tal, senior economist with CIBC World Markets.
Mr. Gordey is one of the unlucky ones because he had a variable-rate mortgage that was negotiated at .375 percentage points below prime, but he switched to the line of credit. Instead of borrowing money at just above 1.85%, his loan is now 3.25%.
The difference between the rules on a variable-rate mortgage versus a line of credit are subtle but important. Most consumers taking out a variable-rate mortgage agree to a term with the rate calculated based on prime. These days, that’s about 100 basis points above prime. Before the credit markets blew up, it was 60 basis points below prime.
“Historically, a lot of lines of credit have been priced right at prime,” says Gary Siegle, a mortgage broker and Calgary regional manager with Invis Inc. “The typical range has been from prime, to prime plus two [percentage points], depending on your credit.”
Mr. Siegle says credit lines are great for consumers because they operate like credit cards, but with nowhere near the same interest rates. And, unlike mortgages, you can opt to pay just the interest.
The downside? Most lines of credit are callable upon demand, even if you have not defaulted. Most mortgages are not. To keep this point in context, it is almost unheard of for a Canadian financial institution to call in a consumer line of credit that is not in default.
The major difference is your rate and the bank’s ability to change it on a line of credit versus a mortgage.
Variable-rate mortgages are tied to prime, which banks can set at any level they want. But the reality is, Ottawa has leaned on them to keep the prime rate moving in step with the Bank of Canada’s rate, regardless of the cost of debt. There were a few hiccups in the fall, but the banks played ball as rates have been lowered.
Lines of credit are a different story. At Bank of Montreal, they are calculated using what is called “the base rate,” which is a combination of the prime rate plus whatever discount or premium the bank is willing to offer customers.
Unlike consumers with variable-rate products, who have contracts that specify they get a certain discount off of prime, the rules on a credit line tend to be looser and allow the banks to raise your rate as their costs go up.
“Our base rate has been adjusted. All the banks have done it because of our cost of funds,” says Laura Parsons, area manager of specialized sales for Bank of Montreal in Calgary. “The base rate can move. It is prime plus something.”
The “something” is something to think about.
Dusty wallet Is your interest rate calculated on a daily, monthly, quarterly, semi-annual or annual basis? It can make a difference in your effective interest rate. On a 4% mortgage, if interest is calculated daily, the effective rate is 4.0808%. If it’s calculated monthly, it’s 4.074%; quarterly, 4.06045%; and bi-annually, 4.04%. How your interest is calculated becomes a much bigger issue as you get into higher rates
Side note: We still have variable rate mortgage available between prime plus .40 and prime plus .60 so effective rate for your variable rate mortgage is between 2.65% and 2.85%. Line of credits are a different type of credit vehicle and not for everyone, they do have some more flexibility with things such as interest only payments and if you need credit in the future your dont have to go back to the bank to access it. Credit lines are priced at more of a premiume at prime plus 1% and higher today.