Choosing the best home equity loan
By Peter Diekmeyer • Bankrate.com

One of the biggest changes in the financial services industry in the past 20 years is the increasing flexibility offered to consumers. In few sectors is this more apparent than in home equity loans.

"They have more choices than ever," says Noel Roy, director of mortgage products at Fédération des Caisses Desjardins in Montreal. "Today it is much easier to get access to new credit."

Home equity loans have traditionally fallen into two categories: term, or closed-end loans, and lines of credit. In the past, home equity loans were often referred to as second mortgages because they were secured by your property, just like a mortgage.

But in recent years, a new type of product known as a split mortgage has become available, letting consumers add a second borrowing vehicle -- either a line of credit or an additional loan -- to their original mortgage.

Home equity loans and lines of credit
Home equity loans and lines of credit usually have shorter terms than mortgages. The most common type of mortgage runs 25 or 30 years, while equity loans are typically five to 15 years.

A home equity loan, sometimes called a term loan, is a one-time lump sum that is paid off over a set amount of time, with a fixed interest rate and the same sized payment each month. Once you get the money, you cannot borrow further from the loan. To see current home equity loan rates, check out Bankrate's Home Equity page.

A home equity line of credit (HELOC) works more like a credit card. You are allowed to borrow up to a certain amount for the life of the loan -- a time limit set by the lender. During that time you can withdraw money as you need it.

As you pay off the principal, your credit revolves and you can use it again.

For instance, let's say you have a $10,000 home equity line of credit. You borrow $5,000, but then pay back $3,000 toward the principal. You now have $8,000 in available credit. This gives you more flexibility than a fixed-rate home equity loan.

Credit lines have a fluctuating interest rate. Payments vary depending on the interest rate and how much credit you use. When the life span of a line of credit has expired, everything must be paid off. A lender may or may not allow a renewal. Bankrate's Home Equity page also displays current home equity line of credit rates.

Lines of credit are accessed by specially issued cheques or credit card. Lenders often require you to take an initial advance when you set up the loan, withdraw a minimum amount each time you dip into it and keep a minimum amount outstanding.

Financial institutions negotiate a home equity loan just like they do a mortgage. You have to pay off the loan or line of credit when you sell the house.

Split mortgages
In recent years, Canada's large financial services institutions, including Desjardins Group, National Bank of Canada and Scotiabank, have begun offering split mortgages, which are increasingly taking the place of traditional second mortgages.

Split mortgages enable banks to break down a homeowner's mortgage into several borrowing vehicles of various terms. For example, a homeowner with a $100,000 mortgage who expects to inherit some money in the near future may elect to pay off a portion of his mortgage within 25 years and take on the balance as a line of credit.

According to Gillian Riley, vice president (mortgages) at Scotiabank in Toronto, split mortgages are traditionally only offered to low-ratio customers, those who borrow less than 75 percent of their homes' assessed value.

Nevertheless, split mortgages offer an attractive alternative to consumers who would otherwise take out a second mortgage. After an updated credit review, the bank just cuts a cheque and adds the balance to the original mortgage, without having to register a second charge.

According to Charles Provost, a product manager at National Bank of Canada in Montreal, which launched its Multi-choice split mortgage option six years ago, the product has rendered home equity term loans almost useless.

"Clients are almost always opting for either the split mortgage or the home equity line of credit," he says.

Which type should you choose?
The answer to this question is seldom black and white.

But there are some scenarios where the choice is obvious. For example, let's say you need $7,000 to pay for your daughter's wedding next month and $3,000 to fix your roof, which will take a week.

You know exactly how much you need, and both amounts are due in full fairly quickly. If you don't have plans to borrow again, a straight home equity loan for $10,000 is more suited to your purpose.

But if you need money over a staggered period of time -- for example, at the beginning of each semester for the next four years to pay for your son's schooling or for a remodelling project that will take three years to finish -- a line of credit is the better choice. It gives you the flexibility to borrow only the amount you need, when you need it.

And if you borrow relatively small amounts and pay back the principal quickly, a line of credit can cost less than a home equity loan.

Want a home equity loan? Check rates in your area.

Consumers who have run up credit card debt will often borrow a lump sum and pay off their Visa, MasterCard and department store charges, then pay back the bank over time at a lower interest rate than the cards would have imposed.

This sort of debt consolidation is the single most-popular reason people have for taking out home equity loans, and fixed-rate home equity loans are used slightly more often than lines of credit for this purpose.

To help you determine which loan best suits your needs, ask yourself:

• When do I need the money?
• For how long do I need the money? Is it for a short-term or long-term purpose?
• How long will I need to pay it off?
• How big a monthly payment can I afford? Would a line of credit tempt me to use the money carelessly because it works similar to having a credit card or chequing account?

Ask your lender:

• How long is the term of the closed-end loan?
• What is the life span of a line of credit?
• How large a line of credit do I qualify for?
• Is my line of credit renewable when the life of the loan expires?
• What are the interest rates?
• Do I have to use my credit line right away? (If you're opening a credit line for future or emergency needs, you'll want one that doesn't require a minimum draw at closing.)
• Under what circumstances can you freeze, reduce or demand full payment of my loan?
• Can I lease my house during the loan period?
• Will you loan to me if my house is on the market (and at what rate)?
• If interest rates go down, how low will my loan go?

Peter Diekmeyer is the Montreal Gazette's management columnist.