A borrower's dilemma
By Jim Middlemiss • Bankrate.com

When it comes to spending, Canadians seem to have no limits, and our purchasing prowess is actually outstripping our ability to save. Whether it's buying a new car, renovating a home or purchasing another big-ticket item, Canadians are spending often and usually with borrowed money.

According to Statistics Canada's latest figures, 47 percent of Canadians spend more than they earn. Most do it by taking on debt, rather than selling existing financial assets to raise the dough they need to buy things.

But what's the best way to finance a big-ticket purchase? You can put it on a credit card, but the interest rates, which can range between 10 per cent and 20 per cent, depending on the type of card, can make it very expensive financing.

For most other items, be it a boat or a bathroom renovation, you’re likely looking at some sort of loan. And on that front, you have two options: a mortgage or a line of credit. But which one should you use and why?

"It depends really depends on the individual," says Michael Klatt, director of product and financial management at Investor's Group in Winnipeg. Some people want interest rate flexibility, and if that's the case, he says a line of credit might be the solution, because it fluctuates as interest rates rise and fall. If you're looking for more peace of mind, a secured, fixed-rate mortgage may be the way to go.

In this corner: lines of credit
There are two types of lines of credit: unsecured and secured. An unsecured line of credit is backed simply by your good name, and it's up to you to make good on what you owe. You can secure that line of credit with an asset, such as your home, in which case it's known as a home equity line of credit, or HELOC. It allows you to tap into the equity in your house, using it as collateral against which to borrow.

A line of credit is extended for a set amount of money, and you can draw on it until you reach the maximum. The amount you can borrow from an unsecured line of credit is usually lower than how much you can borrow with a HELOC. That's because banks don't want you to go broke and leave them with nothing to collect on.

Lines of credit are usually based on a variable interest rate, and HELOCs come with lower rates than unsecured lines of credit, usually between one per cent and 1.5 per cent lower. For current rates in your area, check out Bankrate.ca's home equity home page.

The minimum payment you need to make each month is the interest owed, similar to a credit card. You can choose to pay off as much as you like beyond the minimum interest payment and make a full repayment at any time without penalty.

Patricia Lovett-Reid, senior vice-president with TD Waterhouse, in Toronto, says that with a line of credit, "you get access to the money right away. The interest rates are based on a spread plus prime (and) the spread typically narrows as you borrow more." As well, she says, with a HELOC, the amount you can borrow is related to the amount of equity in your home. The more equity you've built up -- that is, the greater the amount of the mortgage you've paid off -- the less you'll pay in interest.

Lines of credit are also usually demand loans, meaning the bank can demand full repayment at any time. So, if you suddenly lost your job, you could be asked to cough up the outstanding amount owed.

And in this corner: the mortgage
Your other option for financing a big-ticket item, such as a renovation, is to take out a mortgage or increase your existing one. Klatt says a conventional mortgage provides more assurance than a HELOC when it comes to repayment. Like a secured loan, your house is used as collateral.

Instead of simply paying interest, you are required to pay a blend of interest and principal each month. You know at the outset how much your monthly payment will be, and there is an established timetable for paying back the loan. Normally, you can't make an early repayment in full without paying a penalty.

With a mortgage, you can take advantage of a fixed interest rate, so you won't be hurt as rates spike, but you won't be able to take advantage of dips either. To check out the best mortgage rates in your area, check out Bankrate.ca’s mortgage home page.

Deciding between the 2
Klatt says cost is a big consideration when picking which type of financing vehicle to use. "It really depends on how long you plan to carry the debt. That will determine the overall interest cost."

For example, if you borrow $10,000 for a bathroom renovation using a unsecured line of credit at the current rate of 7.5 per cent and that rate doesn't change (which is unlikely), then over three years you will pay $2,250 in interest and still owe $10,000.

If you borrowed using a HELOC with a lower rate of six per cent, you would pay $1,800 in interest, about 25 per cent less. Because it's an open loan, you can control how much interest you pay by simply paying it off faster.

If you borrowed the same $10,000 with a three-year, fixed-rate, closed mortgage at the current average rate of 6.75 per cent, you'd pay about $1,060 in interest by the time you pay off the loan (assuming you made no extra payments along the way). But you also wouldn't have a chance to pay your loan off early without paying a penalty.

For people who work on commission or are self-employed, Klatt says a line of credit may be a better option, as it is an excellent way to help regularize payment streams. "You can pay down more or make interest-only payments. You have greater flexibility and control if have the discipline to manage cash flow appropriately."

In the end, when it comes to figuring out the best way to borrow money for your own purposes, you have to weigh the options. Lovett-Reid warns that if you borrow against your home, it will take longer to pay it off. And if you have to keep in mind that if you do so to get a cheaper rate and become unable to pay off a secured loan or conventional mortgage, "the lender would claim your property and you would lose your home." You want to weigh the pros and cons of any kind of borrowing what are the consequences if you fall on hard times.

Jim Middlemiss is editor of Canadian Lawyer magazine and is based in Toronto. He's a frequent contributor to the National Post and Investment Executive.