For most people, buying a house is the biggest decision they’ll ever make. So it’s no wonder that having to pay for thing over the next 25 or 30 years makes a lot of people pretty anxious. After all, it’s a pretty intimidating transaction.
First you have to assemble a stack of cash for the down payment and closing costs. Then you have to convince someone to lend you an even more staggering sum – generally 80% or more of the purchase price. Then there’s the actual mortgage decision. Everyone knows friends or relatives who, lured by record low interest rates, have stretched their budget buying homes only to find themselves struggling to keep up with not only colossal mortgage payments, but with more than a few unexpected expenses as well.
Rates not the only factor to consider
But it’s not simply about interest rates. Ask yourself these questions: How long do you plan to live in this house? Will you have or hope to make home improvements? Where do you see yourself in five or 10 years? Is your relationship stable? Is your family growing? What’s your cash flow going to look like?
If you’re going to stay in your house and plan to pay off your mortgage gradually, you may prefer get a fixed rate loan where the payments won’t change. The interest is a little higher than with a variable-rate mortgage but you have the security of knowing what your loan payments will be.
Is it the right time to lock in?
Most studies say that variable-rate mortgages have worked out to be better than fixed-rate mortgages over the past 25 years. And the difference has been fairly dramatic, saving homebuyers thousands in potential interest costs. But is this likely to be the case going forward? And how long out should you go? The mortgage term you choose can have a far greater impact on borrowing cost than your up-front interest rate. That’s because your term determines the length of time you're locked into a rate that might not be that great a deal.
Think twice about the term you want
According to a recent survey from the Canadian Association of Accredited Mortgage Professionals, a scant 3% of all buyers with a fixed rate mortgage have it locked in for 10 years. The five-year mortgage is still far and away the most popular choice among fixed rate mortgages, chosen by 51% of all Canadians. Only 2% have been going with a one-year rate. Shop around, though, and you’ll find one-year mortgages at less than 2%. That’s actually lower than many variable rates. The benefit of a short-term mortgage like this is that it renews more often, improving your odds of being able to get out of the mortgage without a penalty.
Will I have the cash to spare?
Mortgage penalties are straightforward if you have a variable-rate mortgage – expect to pay the equivalent of three months’ interest in most cases.
With a fixed-rate mortgage, the penalty is set at the higher of three months’ interest or a calculation called the interest rate differential or IRD. An open mortgage means you can repay the loan at any time without penalty. Interest rates are usually much higher on this type of loan, but if you see yourself selling in the near future or expect to receive an inheritance, the premium might make sense.
When to push for prepayment
Full-service mortgage products usually come with the ability to pay an extra 20% on top of your monthly payment, and a 20% lump sum payment of your total mortgage annually.
As the cash goes directly toward the principal, this is a great way to shorten your overall amortization by a few years, and save big on interest payments. However, not all mortgages are so generous - it's common for ultra-low rate products to skimp on the prepayment, offering only 5% to 10%.
This can be a deal breaker for those intending to pay their mortgages down quickly -- but many first-time buyers aren't in the financial position to do so within their first five-year term. By contrast, homeowners who have five to 10 years' worth of equity under their belts may be able to take an aggressive approach to prepayments, and should consider this feature when shopping for their renewals.
Can I take it with me?
If you’re considering moving in the near term, your mortgage will have to be paid off – unless you’re able to port or transfer it to your new house.
Porting a mortgage really only makes sense if your current interest rate is significantly lower than those being offered elsewhere. Otherwise, you’ll likely be better off breaking the contract and paying the penalty.
Could I have yours instead?
Maybe the new house you’re considering comes with its own mortgage. While mortgage assumptions have largely disappeared in this time of falling interest rates – why would anyone want to take over somebody’s existing mortgage when they can get a lower rate today? Mortgage rates will eventually go up again.
An assumable mortgage can be taken over by the buyer of a home although they have to apply and qualify for the mortgage in order to assume it. Make sure the rate is attractive and that there’s enough term remaining to make it worthwhile, however.