Short vs. Long term mortgage - What is best for you?

Almost every time that I arrange a mortgage for one of my clients they ask me whether they should go with a shorter or longer term.

My answer: for some people having a long-term mortgage makes a lot of sense, for others a short-term mortgage will best meet their needs.

Of course there is no one right answer here.

When you are selecting the term for your mortgage it is important to recognize that generally the longer the term of your mortgage, the higher the interest rate.

A good way to think of the difference between a short vs. a long-term rate is an insurance premium. The financial institution generally wants to be compensated by you in order to be compensated by you in order to guarantee the rate of your mortgage over a longer period of time. What you have decided is whether or not the insurance premium (difference between short vs. long term rates) is worth paying in your circumstances.

Many people have heard the theory that you are better off to keep on renewing with short terms and paying down your mortgage. This philosophy has held true in the past provided that the extra amount that you save from selecting a short term is applied to reducing your principle mortgage balance outstanding.

There is potential to gain by using this method, but you are also exposed to risk that rates could be substantially higher by the time you have to renew.

Many of the consumers in today’s market are buying homes with 5% down and extending their debt servicing to extreme levels. While I believe that the dream of home ownership is a very fulfilling and a worthwhile pursuit, I caution that you should do your financial planning carefully.

It is important to realize that interest rates today are at near historical lows. Many people who can afford homes today would never have been able to make that purchase at the interest rates of five years ago.

It is critical that you understand the following: YOU REPAY VERY LITTLE OF YOUR PRINCIPAL BALANCE IN THE FIRST FEW YEARS OF YOUR MORTGAGE.

This means that the people who are in jobs that will likely see very little pay increase over the next few years should definitely consider the consequences. Historically, over the last 30 years the average five-year mortgage rate has been approximately 11%.

Ask yourself this question: if mortgage rates are at 11% when you have to renew- will you be bale to afford to keep your home?

If your answer is a comfortable yes, then I suggest that you pick the term that you feel happy with.

If your answer is even possibly no, then find as long term as possible. By the time a 10 year term comes up for renewal you will at least have paid a large portion of your principal off, and may be able to extend your financing over a longer term in order to make your payments more affordable.

If the property you are financing is being used, or is going to be used as an investment property then again the longer-term mortgage product also makes sense.

Remember there is no mortgage product that can be all things to all people. Make sure you get informed and find the product that best meets your needs. Until next time, best of luck finding your mortgage and home.

Be Financially Smart and NOT Ignorant!!!

I want to thank Maria who called me 2 weeks ago for encouraging me not to stop writing these articles. Sometimes, I wonder if anyone is actually reading them. But, I am glad that there are those who still read and not just listen to the news on TV.

I want to review some things that I believe are extremely important for people to know prior to making decisions that are not wise. The million dollar question is to fix or not to fix your mortgage? Those who decide to fix are not making a smart decision.

Why? 

Most first time homebuyers make the mistake by going with a 5 year fixed mortgage. They do this because they want peace of mind and do not want to think about their mortgage any further. Like most people, especially those who work in construction, do not have the time to keep an eye on the rates. They leave the house at 6 am to start their work day at 7 am. They usually get home around 6 pm. They will have dinner with the family and try to spend some quality time with them. Then around 9 or 10 o’clock in the evening they are watching the news and then all of a sudden the TV is watching them fall asleep. These individuals think that the interest rates will sky rocket from 2.89 (today’s 5 year fixed) to 8 or 9% overnight which is IMPOSSIBLE.

I have been advocating variable mortgages for the last 15 years. Those who took my advice are now laughing. But those who didn’t are now crying. Remember when rates go up, no one complains. But when rates go down and you want to get out of the fixed mortgage to take advantage of the new lower rates, there will be penalties to pay. In contrast, a variable to a fixed rate mortgage there are no penalties or costs to lock into a fixed rate mortgage.

In Sept 2010, I met with a client which I will name Sr. Jorge. He had just bought a house and he was quoted a rate for 5 yr fixed at 2.99. I told him that was an excellent rate. However a variable mortgage would be much better. How so? Well, first of all not all banks have a variable mortgage at prime minus 0.80 at 2.20%.  In order to be competitive in the market some banks are offering a low rate for 5 year. They are putting a carrot in the front of the horse to see if the horse will bite on it.

Sr. Jorge was a bit hesitant to go with a variable mortgage but he took my advice and now he is extremely happy with the decision. His original mortgage was $132,875.45. He now owes $91,458.76. So in two (2) years he has managed to reduce his mortgage by $41,417. So you are asking how on earth did he manage to do this?

Very easy!!! He managed to make his monthly payments of $1,329.57 (based on the 5 year fixed) the same on a monthly basis but he went variable. The monthly payments did not change. However, the principle portion increases and the interest is reduced each month.

                                                            Interest                         Principal

            May 01                                    325.66                         1,003.91

            June 01                                    308.09                         1,021.48

            July 01                                     295.62                         1,033.95

So let us do some math at this stage. Based on a mortgage for $250,000 at today’s 5 year fixed rate at 2.89% the monthly payments would be $1,169.03. The principal portion would be $570.54 and the interest 598.49.

But, based on a variable mortgage at prime (3%) minus 0.40 = 2.60% the monthly payments would now be $1,132.39. The principal would be $593.63 and the interest would be $538.76.

Let is now assume that if the prime rate goes up to 3.25 minus 0.40, the variable rate would now be at 2.85%. Based at 2.85% the monthly payments would now be $1,163.94 The principal would be $573.68 and the interest would be $590.26                       

So if you didn’t know any better you would go fixed at 2.89 for a monthly payment of  $1,169.03. However, the smart people would still continue to make that payment of 1,169.03 but go variable.

Why? More principal will be applied towards your mortgage.

By forcing yourself to make the payments of $1,169.03 and not $1,132.39 (2.60% variable) you are still throwing $36.64 more of principal plus the principal portion on the variable mortgage which is $593.63 = 630.27 on a monthly basis. Now $630.27 x 6 months = $3,781.62 towards principal.

Now let us assume that prime rate goes up to 3.25 minus 0.40 = 2.85%. The payments would still continue to be the same at $1,169.03 (still based on the 5 year fixed). However, now the principal portion would be less cause 1,169.03 minus $ 1,163.94 = $5.09 plus the principal portion on 2.85% ($573.68) = $578.77 x 6 months = $3,472.62 towards the mortgage.

In the end result you have thrown $3,781.62 plus $3,472.62 = $7,254.24 AT LEAST towards the mortgage within one year in the variable mortgage.

Why do I say AT LEAST $7,254.24?

Remember Sr. Jorge? His payments never changes per month. But his principal portion would increase each month. That is why he was able to throw $41,417 toward his mortgage within 2 years.

Now let’s compare the fixed 5 year. The principal portion was $570.54 x 12 months = $6,846.48 the difference between the two is $407.76 ($7,254.24 minus $6,846.48).

If 10,000 customers decided to lock into a 5 year fixed mortgage, $407.76 (savings on a variable mortgage compared to a fixed mortgage) the bank would make $4,077,600 millions of dollars.

So, next time when you hear that the banks are making millions of dollars and you get upset, remember you just helped them to make more millions of profit.

Remember folks, math never lies. We tend to make decisions based on emotion and not on logic. If you had a choice to put more money into your pocket versus giving it to the bank, what would you chose? So next time when you hear that the banks are making millions of dollars in profit, remember on thing- you just helped the bank make more money off you by deciding to go with a fixed mortgage.

So be financial smart and not financial ignorant!!!!

For more information contact your Toronto Mortgage Broker at 416-920-9931

Follow me on Twitter

Like us on Facebook

Quick Tips for the first-time homebuyer

Buying your first home is an exciting new experience. Attending open houses, putting in an offer to buy and decorating your new home to suit your style is all part of the excitement. All the decisions that need to be made can also make you feel nervous. Here are a few tips that can help out the anxious first-time home buyer.

How much can I afford?

There are two things to consider when determining how much home you can afford. How much do you have for your down payment? What amount can you afford as a monthly payment while still enjoying life? To help answer these questions talk to a mortgage professional.

To shop for a home with confidence, you can obtain a pre-approval certificate from your financial institution. This document will tell you how much of a mortgage you can afford.

How much do I need for my down payment?

You can buy a home for as little as 5% of the purchase price. However, any mortgage with a down payment of less than 20% has to be insured by a third party such as the Canada Mortgage and Housing Corporation (CMHC). The amount of your down payment will determine whether you need to insure your mortgage or not.

• Conventional Mortgage- a mortgage where you have at least 20% of the purchase price.
• High-Ratio Mortgage- a mortgage where you have less than 20% of the purchase price.

Your insurance premium will depend on the amount you are borrowing and on the percentage of your down payment amount. Premiums usually vary between 1.00% and 2.75%.

How can I save for a down payment?

There are a few different methods that can be used when saving for your down payment:

• Setting money aside each month just as if you had to make a monthly payment
• Opening a RRSP investment account. If you are a first-time homebuyer you and your spouse can use up to $25,000 each towards your down payment without tax implications as long as you repay the amount within 15 years.
• A cash gift from a parent or relative.(“gift” means its non-repayable)

Should I be aware of any additional cost?

Your mortgage will cover off the purchase price of your home, however there are other costs and can usually amount to 1.5% to 3.5% of the total cost of your home. Here are a few examples of the hidden costs of home ownership associated.

• Appraisal fee
• Home inspection
• Property survey
• Land transfer tax
• Legal fees
• Sales tax
• Title insurance
• Home insurance

Also, don’t forget to consider general expenses such as moving and home decorating costs.

Always be an informed client.

For more information contact your Toronto Mortgage Broker at 416-920-9931

Follow me on Twitter

Like us on Facebook

Mortgage lenders view six factors when evaluating applications

Does applying for a mortgage seem too complicated? Knowing how your application will be evaluated will better equip you to evaluate your financial strengths and weaknesses. Having all your documentations ready will make the approval process much quicker and easier.

Lenders look at six factors when evaluating an application your identity, your income, debts, employment history, credit history, and the value of the property.

YOUR IDENTITY

In order to protect against mortgage fraud, the lender or their lawyer will require picture identification to ensure you are the individual you represent yourself to be. In addition, you may be asked questions regarding your credit history to verify information on record at the credit bureaus.

YOUR INCOME

The lender will measure your income level against the amount of the mortgage payments, property taxes and condo fees, to decide whether you can comfortably afford a home. Your lender will compare your current housing expenses to the expenses you’ll have if you buy a home. The smaller the increase, the stronger your application looks. Usually a guideline of 30 per cent of your pre tax income is used to determine your maximum payment level.

YOUR DEBTS

The lender will look at your debts, including your anticipated house payments, as well as all loans, credit cards, child support and any other payments that you make each month. The ratio of the payments on these debts to your gross monthly income results in a total debt service ratio. The generally accepted total debt service ratio for all housing and other obligations is 42 per cent of your pre tax income.

YOUR EMPLOYMENT HISTORY

Mortgage lenders are more likely to lend money readily to people who have a history of steady employment. You will need to provide a letter or pay stub from your employer and the lender may further verify your employment by contacting your employer. If you are self employed or have been at your job less than two years, they may ask for other documentation, such as business financial statements or federal income tax returns.

YOUR CREDIT HISTORY

Good credit is very important in qualifying for a loan. A mortgage lender will look at your credit record to see how well you’ve paid your loans and other debts in the past. If you’ve never had a loan or credit card, you can still demonstrate a good record by showing timely payments of utility bills and rent. It’s a smart idea to review your own credit report and score before applying for a loan. For a small fee, a credit bureau will provide an instantaneous, complete online credit report and credit score that details your current debts and payment history. They also detail what your score level means, how you compare to others, and provide tips to improve your score. You also may receive tour credit report (without the credit score) by mail for free by contacting the credit bureau.

THE PROPERTY’S VALUE

When purchasing a property, you should be comfortable that the price you are paying is reasonable and will be acceptable to the lender. You can usually confirm the value is reasonable by obtaining an appraisal from an accredited appraisal professional or from the Realtor who is representing you in the purchase. Some purchasers may also obtain a property inspection to confirm the property’s condition and identify any items that may require repairs.

Lenders also tend to evaluate your application against the following guideline:

• A housing expense ratio no greater that 35 per cent (the lower the ratio, the better)
• A debt-to-income ratio for all debts no greater than 42 per cent (the lower the ratio, the better)
• The home buyer has steady income ideally, the same job for two years or longer
• The home buyer had good credit (bills have been paid on time)
• The house is worth the price the buyer is paying

Always be an informed client.

For more information contact your Toronto Mortgage Broker at 416-920-9931