Financial Friday #136: Mortgage Misunderstandings can Cost BIG!
Misunderstanding your Mortgage a Costly but Common Mistake
A January 2022 survey
found that one third of Canadians spent more time planning their next vacation than investigating the options, details, and possible outcomes of their mortgage agreement! Quite shocking considering it is a long-term, legally binding financial commitment that is critical to your financial and overall well-being.
This "lack of interest" may have been due to a "lack of interest" as record low rates kept payments manageable and debt servicing costs off our radar. Unfortunately, many people found out the hard way as rates spiked in 2022 that failing to understand the terms and conditions of your mortgage can lead to some nasty surprises.
Mortgages are in the news a lot these days as interest rates are expected to rise further
before the end of the year and home prices are dropping in many markets, but there is a lot more to consider than just the interest rate. Here are a few things worth digging into if you are renewing your mortgage or looking at how to finance your first home.
The choice of a fixed vs variable rate.
The two factors at play here are your risk tolerance and future interest rates. Fixed rates lock in your monthly payment for the duration of the agreement with five years being the usual term. The catch is that fixed rates are higher, although the gap is currently almost nothing with the best fixed and variable rates both hovering around 5%. This is quite a change from 2021 when fixed loans commanded about a 1.5% premium over variable rates and Canadians flocked to variable rate mortgages.
Which one is best for you depends a lot on your risk tolerance, but you should look closely at how the numbers could change before making any decision. If you have a 5-year fixed mortgage and are renewing in 2023, you are probably looking at around a 2% increase from when you locked in your rate back in 2018. For a $400K mortgage that works out to an increase of almost $500/month.
Variable rate mortgage holders have already seen their payments skyrocket in 2022. The 3.75% increase in the Bank of Canada rate has added around $850 monthly to a $400K mortgage, and it is likely to rise again in December. The big difference is that variable rate holders got hit hard and fast while fixed rate holders (depending on their renewal date) may have a little more time to prepare for higher payments.
Renewing? Don’t trade convenience for anything!
Renewing your mortgage with your current lender is a great time-saver, but make sure to shop around and compare rates as well as adjust any terms and conditions to reflect changes in your lifestyle. It isn’t only about the rate, and keep in mind that the lowest rates often come with the least flexibility. Going forward, you may want to switch from variable to fixed, add payment flexibility or portability, or some other features.
Failure to get the mortgage product with the options you need will leave you with more than a little regret, it may also leave you on the hook for all sorts of fees and penalties if you need to modify or break the terms of your mortgage. A good mortgage broker is an invaluable resource that won’t cost you anything.
Using your mortgage for "cheap" financing or debt consolidation?
The great thing about a mortgage is the comparatively low rates can save you thousands in interest charges versus other borrowing options. Credit cards can have rates that are two to five times higher, so if you have a credit card balance and equity in your home, you should try and qualify for a home equity loan (but make sure to cut up that card first!).
It’s important to realize that the cost of home equity borrowing has doubled in most cases over the course of 2022 and now stands around 6%. It became quite widespread over the last few years to use a HELOC for discretionary items like cars, vacations, furniture, and home renos, but this is now a lot more costly. If you are borrowing equity, make sure you factor in the higher cost and understand your repayment obligations... and have a repayment plan (it’s not free money!)
Should I pay my mortgage off early?
If this is on your mind, the first thing you need to do is confirm what sort of accelerated payments you are allowed to make. There may be limitations on the amount or timing of payments or a number of other rules in your mortgage agreement.
The other consideration is what else would you do with that extra money? If you lack discipline and would spend it, pay off the house! If you would wisely invest it, the decision is not so clear. Financial markets are way down this year and interest rates are way up, so paying down the mortgage isn’t looking like a bad idea at present. However, things can change quickly and there are a lot of other factors in play, so do your research and get out the calculator and start crunching some numbers!
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