Hybrid Mortgage Products: Best Invention Ever or Revolving Door of Credit?

The answer IMHO is a little bit of both.

So, what is a hybrid mortgage?  It is basically a multi-segmented, collateral charge mortgage that allows you to have multiple mortgages and line of credits at different interest rates, terms, and lengths.  All the Big 5 Banks and a few other lenders offer a product like this, and it usually has a fancy name to match (Equity plan, Readi/Flex/Home Line).

These Hybrid Plans are among some of the most popular products with consumers and are at the forefront of most bank lender’s sales strategies, often positioned as a total credit solution.

Some of the pros?  These plans are convenient, they give you access to low-cost borrowing that you don’t need to qualify for later on, and they can help with personal accounting/planning by allowing you to set up different sections for different purposes (i.e., one segment for home renovations, one for education).

Some of the cons?  It can be harder to keep track of balances, it can end up costing you more in interest, and because some of the credit is open it can stall the pay down of your mortgage if you’re not proactive.

I worked for a major bank for a decade, and these products are always the hardest to explain because they are not as straightforward as your standard, conventional, vanilla mortgage.

Imagine your Hybrid Plan is like a big cup with two compartments – a mortgage with a regular payment, and an equity line of credit at a fluctuating rate with interest-only payments required.

As the water goes down in one compartment (the term mortgage) it rises in the other compartment (the line of credit) so you’re always maintaining the same total limit. The difference is how the funds are allocated.

For example, if your plan limit is $500,000, and you choose a 5 Year Fixed mortgage for $450,000 of the funds, then the equity line of credit would have $50,000 available on it.  When you pay the mortgage portion down to $400,000 the equity line of credit portion will have increased to $100,000.  The key word here is re-advanceable, meaning that as you pay down the principal on your mortgage it readvances and becomes available on your credit line limit.

I do like these collateral options for the right circumstances.  If you know that you have a big home renovation coming up that you’ll be paying for over several months, or if you’re planning to buy a vacation cottage for the family but don’t know exactly when and want to be ready to go with the deposit, these are ideal situations to have an equity line of credit in place.  That said, once the money has been drawn in a lump sum it might be time to start thinking about your repayment strategy.  The good news is that you can usually term out your credit line balances as mortgages at competitive rates with a regular principal and interest payments (which will save you money).

Who this product isn’t for?  If you have difficulty managing revolving credit or find yourself tempted to dip into your line of credit for daily expenses and discretionary items then the structured repayment of a conventional mortgage might be the better solution. 

Some food for thought?  There are provisions in these products that allow the lender to a) increase the rate at any time b) close the revolving credit c) freeze the limit which they will sometimes do if the equity line is not being managed well (i.e.. it’s sitting at or over its limit with little to no repayment, or if you put secondary financing behind the mortgage).  While it may not be a common occurrence if you have a home equity line of credit that’s not budging it is probably time to sit down to discuss alternatives.

But my banker told me that I’ll save the most interest with this kind of a plan.

Maybe, or maybe not.  If you’re rocking a bunch of high balance credit cards and unsecured lines of credit then it could be a good strategy to reduce your interest while keeping payments low, but you want to make sure that the comparison is always apples to apples.

For example, if you’re being advised to pay off a 5 Year 5% car loan by putting it on your equity line of credit because it’s at a lower rate of interest, while you would see some interest savings upfront if you don’t have a concrete plan to repay that vehicle loan in a set amount of time then that 5 Year car loan could turn into a 30-year obligation.

If you pay off your credit cards regularly and don’t use much revolving credit in general then there may be no point to this product for you.

Lastly, I’m including a scenario below to show you the lingering effects of paying interest only on an equity line of credit:

Jane has a mortgage of $300,000 at 2.69% with 20 years amortization remaining.  She wants to buy a $100,000 motorhome and the dealer offered her a 15-year loan at 4.99%

She calls her banker who offers her the hybrid mortgage, telling her that it’s cheaper because the interest rate is prime plus 1% (currently 3.45%) and she can pay as much as she likes to the loan as long as she makes the minimum interest per month.

Jane agrees and they set up the hybrid product.  Now Jane has a $100,000 line of credit she’s paying $345/month in interest on (assuming that prime rate never goes up).

If Jane takes the dealer loan at the fixed rate she’ll have paid about $42,000 in interest by the end of 15 years, and the loan will be paid in full.

If Jane pays interest only on her line of credit for 10 years she’ll have paid almost the exact same amount in without any principal reduction.  And the effect of this is further multiplied when you consider future prime rate increases (which are pretty much guaranteed to happen over the next decade).

Equity lines of credit in and of themselves aren’t a bad idea – they’re actually pretty handy to have and are structured to be as open and flexible as possible.  If it turns about to be your preferred product then it’s best to ensure that you’ve set up a regular payment for any large balances so you’re tackling some principal.  There are also lenders (like Scotiabank) who offer a great feature where you can turn off the automatically increasing limit if you’d rather not see that limit increase over time.

Sometimes I think there’s an attachment to the idea of the freedom and flexibility an equity line of credit represents, but realistically if you’ve run it up to its limit and you don’t anticipate a big windfall to pay it off, then why wouldn’t you want to structure it into a mortgage at a lower rate?  I’ve had extremely rate sensitive clients shopping for the best fixed mortgage rates who choose to leave their line of credit balances in place. In my opinion, that doesn’t make much sense, because any savings they get on the fixed mortgage will be quickly eaten up by the line of credit they’re holding at an above prime rate.

Questions?  Let’s talk.