HELOC vs PLOC

The basic principle of a line of credit is fairly straight forward…the bank thinks your credit rating is good enough to justify borrowing you more money than they already have.  

As I mentioned in my last post, I think it is a good idea to gain access (but not necessarily use) a line of credit as soon as you can.  The reason for this being that it is a good safety net to have in case of any unforeseen events.  Used PROPERLY, it can also be used for investment purposes, although I would not necessarily recommend this route….investing with borrowed cash can often turn ugly if you do not know what you are doing.

So you have decided to gain access to a line of credit?  Good stuff.  DON’T use it as your piggy bank and DO pay off the balance as quickly as possible.

Next question: Personal line of credit (PLOC) or Home equity line of credit (HELOC)?

Well if you don’t own a home, the answer is fairly obvious.  For those that do own a home, I would argue that the HELOC is the better option due to the flexibility of payment options and the lower overall interest rates, but I will go over the differences.

The PLOC is fairly easy to obtain.  At your local bank, you will fill out an application, giving them your basic info.  They run a credit check, calculate how much debt you are servicing otherwise (car payments, mortgage, credit card, etc) and come back with a “yes” or “no”.  If yes, they attached a dollar value to the approval and you are all set.  

The interest rate is also dependant on your credit history.  The better your credit, the better your interest rate, although this rate will never be lower than a HELOC.  The reason it is always higher is that it is “unsecured”, meaning you are not putting up anything as collateral in case you take the money run.   

The payment terms are slightly different at each bank, but at TD the ‘repayment term’ is 3 years, meaning that if you max out your credit, say $15,000, you need to repay $416.66 per month, plus interest.  This is automatically taken out of your account each month.

HELOC is slightly different.  The premise behind it is that the banks will lend you cash up to 80% of the value of your home, less any mortgages outstanding. 

If you have a $250,000 home and have a mortgage on the property of  $215,000….sorry, no HELOC for you.   The Loan to Value ratio is above 80%....(215/250 = 86%)

But if you had a mortgage of $170,000, you would be eligible to borrow $30,000, provided the credit check comes back relatively clean and your house has been accurately valued at $250,000

80% of $250,000 = $200,000 minus your mortgage of $170,000 = $30,000

Sign me up right!?

Well, here is where the downfalls come into play.

For one, there is an initial set-up cost.   To get the application process started, you have to put your estimated home value through a computer valuation system at a cost of $99.  The tough part is that you have to estimate the value of your home by yourself!

If you estimate incorrectly….your application is denied and you need to have a ‘human’ appraise your home at a cost of $300….so make sure your  valuation is correct the first time! J

Registering your HELOC on title comes with a cost of another $495, so worst case scenario, you are looking at $795.

Yikes you say!...well yes and no.

Let’s look at an interest comparison.  The interest rate on my PLOC was 5.25%.  The rate on my HELOC is 3.7%.  If I have a drastic emergency and need $25,000 fast, the interest for 1 year on that money at 5.25% is $1312.50.  At 3.7%, the interest is only $925….a savings of $387.50

And remember, you may have this HELOC for a long time, so you will make up the up-front cost through interest savings.

Payment terms are also an advantage for the HELOC.  The minimum payment is interest-only, meaning if you borrowed $25,000 at 3.7%, your cost is only $77 per month….but don’t forget you have to re-pay the principal eventually…and the sooner the better.

So what option is best for you?