Choosing A Term You Can Live With
What term should you take? That's a good question. Before you look at the
issue of term specifically, there are things you should consider:
When you're looking at term and interest rates, look also at what you can
live with in terms of payment amounts, because trying to predict where
interest rates are going is a tough job. There are many forces that
affect Canadian interest rates - economic, political, domestic, and
Even the best economists cannot pinpoint this, so how
can we. You can twist yourself into knots worrying what will happen.
When the rates dropped in 1992 to their lowest in 35 years, no one
thought that they will get that low again. They dropped even further.
Since then we have enjoyed low rates and we don't think of rates going
in the double digits again. That's wrong to assume as well. Who would
have thought in 1978 that rates only 3 years later would go as high as
21.5%? Please check the graph below for a historical account.
Predicting interest rates is very much a gamble and one should be prepared to
keep a close eye on the market.
Here's a suggestion: If you feel that rates are at a point you can
live with and you want to guarantee that rate as long as possible, go
with a long term (5 years, 7 years, and 10 years). If interest rates
appear to be rising, take advantage of the lower rate for as long as
possible, and remember, if you sell your property, you can take the
mortgage with you to the new property or have someone assume the
mortgage. It could prove to be a great selling feature if you have an
assumable mortgage at very low rate.
If rates appear to be falling, you can choose a shorter term (6-month
convertible or variable-rate mortgage) that offers the flexibility to
lock-in to longer term at any time, just in case the rates start going
the other way.
Fixed vs. Variable Rate Mortgages
With a fixed-rate mortgage, the interest rate is set for the term of the
mortgage so that the monthly payment of principal and interest remains
the same throughout the term. Regardless of whether rates move up or
down, you know exactly how much your payments will be and this
simplifies your personal budgeting. In a low rate climate, it is a
good idea to take a longer term, fixed-rate mortgage for protection
from upward fluctuations in interest rates.
A variable-rate mortgage (also called adjustable-rate) provides a lot of
flexibility, especially when interest rates are on their way down. The
rate is based on prime and can be adjusted monthly to reflect current
rates. Typically, the mortgage payment remains constant, but the ratio
between principal and interest fluctuates. When interest rates are
falling, you pay less interest and more principal. If rates are
rising, you pay more interest and less principal, and if they rise
substantially, the original payment may not cover both the interest
and principal. Any portion not paid is still owed, or you may be asked
to increase your monthly payment. Make sure that your variable-rate
mortgage is open or convertible to a fixed-rate mortgage at any time,
so that when rates begin to rise, you can lock-in your rate for a
Closed and Open Mortgages - What's the Difference
open mortgage allows you the flexibility to repay the mortgage at any
time without penalty. Open mortgages are available in shorter terms, 6
months or 1 year only, and the interest rate is higher than closed
mortgages by as much as 1%, or more. They are normally chosen if you are
thinking of selling your home, or if expecting to pay off the whole
mortgage from the sale of another property, or an inheritance (that
would be nice).
A closed mortgage offers the security of fixed payment for terms from 6
months to 10 years. The interest rates are considerably lower than
open, and if you are not planning on any one of the above reasons,
then choose a closed mortgage. Nowadays, they offer as much as 20%
prepayment of the original principal, and that is more than most of us
can hope to prepay on a yearly basis. If one wanted to pay off the
full mortgage prior to the maturity, a penalty would be charged to
break that mortgage. The penalty is usually 3 months interest, or
interest rate differential (I.R.D. - please refer to glossary for
Buy first or sell first?
Which comes first--the purchase or the sale--is the greatest dilemma facing
homeowners planning to move-up.
If you choose to buy first, make sure the offer to purchase is
conditional on selling your current house. That way, if you sell your
house, both deals proceed; if not, the deal is off, and you won't be
stuck with two homes. Selling first though will give you considerable
peace of mind.
how much money you'll get on the sale will help you establish a price
range for the new house. Selling first allows you to negotiate the
purchase more vigorously, too, since unconditional offers carry a lot
more weight with sellers.
Market conditions are another important consideration in deciding which route
to follow. In a seller's market, you'll probably do better selling
after you've bought, but in a buyer's market, it makes more sense to sell.
If you obtained an insured mortgage after April 1'st, 1997, the
premium you paid on the mortgage is now portable to another property
(if you closed before this date, it is not portable, meaning that if
you bought another home and your mortgage needed to be insured, you
must pay the applicable premium again.
The Amortization Period is the number of years it would take to repay the
entire mortgage amount based on a set of fixed payments. The longer
the amortization, the more interest is paid over the life of the
mortgage. Therefore, when choosing the amortization period, careful
planning should be done to meet your cash flows. Remember, the
amortization can be easily shortened after the closing, by simply
making arrangements to increase your payments.
MORTGAGE FEATURES - To Help You Become Mortgage-Free Faster
Monthly, bi-weekly, or weekly payments?
Once you have the mortgage amount, rate and amortization period, your
monthly payment can be calculated. Now is the time to decide how often
you want to make your payments, because by selecting the right payment
frequency could literally mean thousands of dollars in savings. For
example, on a $100,000 mortgage at 8% interest, amortized over 25
years, the monthly payments would be $763.21. However, by simply
switching to bi-weekly payments (every two weeks) with payments of
$381.61 (half of the monthly payment), there would be a saving of
$30,484 in interest! Weekly payments of $190.80 will save $30,839 in
interest, and you will be mortgage free in the 19'th year.
You notice that there is very little difference between weekly and
bi-weekly payments, however. If you have other payments throughout the
month, bi-weekly may be less stressful and easier to budget. If you
are self-employed or commissioned, and your income varies greatly from
week to week, it may be easier to pay monthly and use your prepayment
privileges to knock the amortization period. Also, not all weekly and
bi-weekly payments work the same as above. Let us show you how to manage
your mortgage to your best advantage.
Prepayments - Extra Payments against Principal
This is one of the most important features to look for when you are getting
a mortgage. Having the prepayment privilege that works to your
specific needs could mean a difference of thousands of dollars over
the life of your mortgage. Although all financial institutions offer
some form of prepayment privilege, the amount and how it can be
applied varies from one to another. Some offer only up to 10%, once
per year, and on the anniversary date. Then there are others that
offer as high as 20% per year, and prepayments can be done throughout
the whole year as long as the total does not exceed 20%. Ideally, you
should work your prepayment privilege as often as possible throughout
the year. Saving aside to make that big prepayment is not the best
strategy. We have found that the small, regular prepayments will get
you quicker to that mortgage burning party (I hope we're invited).
Put your tax refund to good use. The average tax refund for Canadians
in 1995 was $1,000. Even this amount will pay large dividends over the
life of the mortgage)
Often times most mortgage shoppers are only looking at rates and overlooking
this interest saving feature. That is why it is important to have a mortgage
specialist make some recommendations for your specific needs. Not only can we
find you the lowest rates, we can also get you the features that will work to
Increase Your Regular Payment
secret to borrowing is borrow early in your life. The reason is that
the future value of the dollar decreases. Why we are bringing up this
fact is that when you borrow early, your payments are set. As time
goes, our incomes increase (hopefully), but our mortgage payments stay
the same, provided you locked-in to a long term, fixed mortgage.
Therefore, in the future we may be in a position to increase our
payment on the mortgage, regardless if you are paying weekly,
bi-weekly, or monthly. Any increase in payment is directly going to
pay down the mortgage, thus saving you thousands down the road due to
the effect of interest not compounding on that amount for the life of
the mortgage. Neat little feature.
this feature varies from bank to bank. Some allow increasing payment
up to 10%, and others as high as 25% per year, some up to 15% only
once in the term of the mortgage. If you increased your payments,
should the need arise, you can go back to the original payments as
well. A mortgage specialist will run a "Mortgage
Reduction" model for you and make some recommendations.
Double-Up on Payments
A few lenders will allow you to double-up on your payments, and the
extra payment goes directly in the principal. If you double-up once in
the year, you have just achieved the benefits of the weekly or
bi-weekly mortgage. This is a neat little feature for someone who
prefers the monthly payments but wants the results of the weekly and
bi-weekly payments. And some lenders allow you the flexibility to skip
a payment if you have made a double payment previously. This defeats
the purpose, but when times are tough, a neat little feature to have.
Early Renewal Option
This is a great feature to have when interest rates are on a rise. If you
are locked-in to a term and the mortgage will be maturing in months or
years down the road, and the mortgage rates are on a rise, you can
renew your mortgage before the maturity and lock-in the low rates for
a new term. You may not even have to pay anything out of pocket and
still save over the term, especially if rates move up considerably.
you want to take your mortgage with you when you move, you can if your
mortgage has a clause that allows you to do that. This option allows
you to continue your savings on your lower rate if the going rates are
higher, as well as avoid any penalties if you were to break that
mortgage. If you need a larger mortgage for the new property, your
existing mortgage amount can be increased. As for the associated
costs, since a new mortgage document must be registered on title,
legal fees and normal appraisal fees would be applicable.
If you are moving and don't want to take your mortgage with you, or you
are selling and not buying, an assumable feature will allow the
buyer(s) of your property to take over the mortgage, providing they
meet the lender's qualifying criteria. By doing so, you will not pay
any penalties as you are not breaking the mortgage contract. In fact,
if your interest rate is lower than those available at the time, your
assumable mortgage suddenly became a great selling feature for your
A word of caution here: Just because someone assumes your mortgage does
not necessarily mean you are off the hook for the responsibility. You
must get a release from the Mortgage Company to ensure that you are no
longer liable for it. Some mortgage companies automatically offer a
release, but with others, you must make the request, and do it through
Life Insurance (optional)
Since your home is likely your single largest investment, you may want to
protect that investment. Many financial institutions offer mortgage
life insurance at an affordable and competitive price, and the
requirements for eligibility are usually quite simple to meet. If you
or your co-borrower (if you choose joint coverage) die, the insurance
company will pay off your mortgage. Also, some institutions now offer
job-loss and/or disability insurance to borrowers. The best thing to
do in making a decision about how to insure your mortgage is to have
an insurance agent work out the figures for a private term insurance
and mortgage life insurance.