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
No comments:
Post a Comment
Note: Only a member of this blog may post a comment.