Interest-Only Line of Credit or Variable Rate Mortgage - Which to Choose?

First of all, both products have one similarity. They both are set to the Prime lending rate. However, an interest-only line of credit (LOC) requires no principal payments, and you only pay the interest owing on the outstanding balance each month. The amortization is "infinity", and you will end up with the exact mortgage you started with at any future date, unless you pay extra in addition to the interest owing. For a line of credit, all banks normally charge their best clients the Prime rate, which today is 4.75%. For example, a $300,000 mortgage will cost you $14,250 of interest annually, or approx. $1,187.50 per month. An advantage of a line of credit is that you can always re-borrow whatever you have already paid down on your mortgage. The lenders refer to this type of mortgage as being re-advanceable. This is a great feature for those who have irregular income or are often purchasing and liquidating investments and require the ability to have access to funds when needed.

With a variable rate mortgage, the interest rate is also set to Prime, but at a lower rate, as the rate is usually set at Prime minus (for example, the rate could be set at Prime minus 0.50%). However, the major difference between a variable rate and a line of credit is that principal payments are required on a variable rate mortgage. For example, a $300,000 mortgage, amortized over 35 years at Prime minus 0.50%, will cost you $1,366.90 per month. Because a small portion of the monthly payment is put towards the mortgage itself, the mortgage balance after 5 years is $279,090.34,. This means your mortgage will have reduced $20,909.66 or an average of $348.49 per month (this is assuming that the Prime rate stays the same over the 5 year period; however, in reality, we will see changes over time, up and down).

The key difference is that you will be paying more for your interest-only line of credit (a half of one percent more!) which on a $300,000 is approx. $1,500 annually!

So which to choose? A re-advanceable interest-only line of credit at Prime, or a variable rate mortgage (with principal and interest payments) at Prime minus 0.50%?

My answer is both! But that's a discussion for another day, so stay tuned for more!