Unsecured Lines of Credit: A Complete Guide for Borrowers
An unsecured line of credit, also called a personal line of credit, is a revolving financing product offered by financial institutions without requiring real estate collateral. Unlike a home equity line of credit (HELOC), which is secured by the property, an unsecured line relies solely on the borrower's creditworthiness. This fundamental distinction explains the significant rate differential between the two products.
Rate Structure and True Costs
Unsecured line of credit rates are generally variable, indexed to the Bank of Canada prime rate, with a premium ranging from 2% to 7% depending on the borrower's credit profile. A client with a credit score above 750 might obtain prime plus 2%, while a weaker profile will be offered prime plus 5% or more. By comparison, a secured home equity line of credit is generally available at prime plus 0.50% to prime plus 1.50%. The annual interest differential on a $30,000 balance can range from $450 to $1,650 depending on rates.
- Revolving credit
- A form of credit where the borrower can draw, repay, and re-draw up to the credit limit without new approval. The minimum required payment is typically interest-only, which can lead to prolonged indebtedness if the borrower does not repay principal.
Impact on Mortgage Qualification
The effect of an unsecured line of credit on mortgage qualification is often underestimated by borrowers. Lenders compliant with OSFI's Guideline B-20 typically use 3% of the outstanding balance as the presumed monthly payment in the TDS ratio calculation. This figure is substantial: a $25,000 balance represents a presumed payment of $750/month, which translates to roughly $100,000 less in mortgage borrowing capacity. Even a line with a zero balance can be problematic if the lender considers the available limit as potential debt risk.
Arbitrage: Unsecured Line vs. Mortgage Refinance
The AMF-certified mortgage broker in Quebec is often consulted to evaluate whether consolidating an unsecured line of credit into a mortgage refinance makes sense. The math appears straightforward: replacing an 8% rate with a 5% rate generates savings. However, rigorous analysis must account for spreading the debt over 25 years (mortgage amortization) instead of a few years, the refinancing penalty if the current mortgage term has not yet matured, and the risk of re-using the line of credit once the balance is transferred. Quebec's Act Respecting the Distribution of Financial Products and Services (LDPSF) requires brokers to act in the client's best interest, which means clearly presenting both the advantages and risks of this strategy.
In summary, unsecured lines of credit play a central role in the financial profile of Canadian mortgage borrowers. Proactive management of these facilities, combined with informed guidance from an AMF-certified mortgage broker, enables borrowers to optimize their mortgage qualification and reduce the overall cost of indebtedness.