In the United States of George W. Bush, back in the early part of the 2000s, interest-only mortgages were more popular than the latest gossip surrounding Justin Timberlake and Britney Spears, a couple I still can’t believe were an actual thing. Like, did he do it for street cred or something?
We all know how both of those things worked out. Even Timberlake’s career isn’t really much of anything these days. And Britney Spears doesn’t get headlines unless she flashes the goods coming out of a limo.
COME ON BRITNEY. WEAR UNDERPANTS FOR GOD’S SAKE.
Interest-only mortgages ended up the worst though. They were a major contributor to the housing crisis, along with things like lending money to anyone who could fog a mirror, and letting people refinance 13 times a year. How people thought this was a good idea at the time still astounds me.
These days, especially in Canada, good luck getting an interest only mortgage. These sorts of products do exist, in the form of the all-in-one mortgages. Essentially, an all-in-one mortgage is just a gigantic line of credit, and each month your whole paycheque goes towards the mortgage. Your balance then goes up as you spend the cash.
The all-in-one mortgages are supposed to save you money, and I believe it. The issue becomes when somebody who can’t control their spending gets one.
It’s easy to make an all-in-one mortgage into one that’s interest-only. All you’d do is make sure the balance stays the same after each month, withdrawing any excess.
Let’s look at an example. Say you owed $250,000 and got paid $4,000 net each month. You’d do this.
Opening balance: $250,000
Excess to transfer out: $1000
Closing balance: $250,000
I assumed a 3% interest rate for the example above. As long as you can invest that excess capital at a return higher than 3%, it’s easy to make the argument that an interest-only mortgage makes sense. It’s about as cheap of leverage as you’re going to get.
Here’s another way you can get an interest-only mortgage, assuming you’re feeling frisky.
Essentially, you’re creating your own all-in-one mortgage this way.
Say you have a $1000 monthly payment, with $625 going towards interest. You then withdraw the extra $375 from a line of credit (secured against the house) and funnel that into your investments. Boom, you’ve accomplished the same thing.
Why would you do it that way compared to an all-in-one mortgage? Glad you asked, grasshopper. It’s because you’ll likely save interest doing it this way. The National Bank All-in-One charges prime+1%, working out to 3.7% annually. It also charges $6 a month for having a bank account through them, which we’ll ignore as a cost you’ll have to pay anyway. You’ll also get charged a quarter point extra in interest if you exceed $5,000, $25,000, $60,000, and $100,000 on the line of credit portion.
So if you owed $125,000 on the mortgage part and $125,000 on the line of credit part, your interest rate would be around 4.2%. That’s not great, especially these days.
These days, a variable mortgage can be easily for less than prime. Plenty of lenders have them available for less than 2.5%, so let’s go with that. You’ll also probably pay another 3.7% for the line of credit, which are usually at a rate of prime+1%.
Using the same example as above, you’re looking at an average interest rate of just over 3%, a significant savings compared to going the all-in-one route. On $250,000, a 1% savings in interest works out to $2500 per year, or more than $200 per month.
There are plenty of arguments against interest-only mortgages. If you’re not responsible, they’re dangerous. And if the value of your house falls a whole bunch, that’s probably not good either. But if you’re looking for a way to cheaply leverage your investing dollars, creating your own interest-only mortgage is a pretty easy way to maximize the amount of capital needed to invest. And if you can beat 3% annually over the long-term, then maybe it’s something you should be doing.