Monday, March 18, 2018
What Type of Mortgage is Right for You?
We begin Mortgage Week at Budget Boss with a look at the different types of mortgages. Buying a home is the ultimate dream for most Canadians. The truth is, owning a home is a valuable part of any solid financial plan. As Canada becomes more desirable on the world stage, our home values, in turn, become more valuable. This has made the prospect of owning a home more and more attractive. Sadly, it has also made the dream of owning a home tougher and more complex. Finding the right type of mortgage is very important as making the wrong choice could cost you thousands of dollars. Today, I will show you several different mortgage options in order for you to find out which one is right for you. Let’s clear the air and get back to the basics.
The Down Payment:
These are down payment amounts that meet the requirement of having a 20 percent of the value of the home, with the remaining 80 percent being provided by the lender. These have a low loan-to-value ratio, which means that the amount of the loan is low, relative to the value of the property. Before mortgage insurance was introduced in the 1950s, almost all mortgages were conventional mortgages, with borrowers paying at least 50 percent of the cost of the home upfront.
These are mortgages in which the borrower has a down payment of less than 20 percent, requiring the lender to provide a higher ratio of the loan. If you’re a borrower with a high-ratio mortgage then you are required by law to get mortgage default insurance, which is commonly known as mortgage insurance. The premiums for mortgage insurance are often rolled into the mortgage loan payments. High-ratio mortgages were generally thought of as being undesirable, but in an environment with historically low-interest rates, high-ratio mortgages are the norm rather than the exception. Even people who might be able to afford the 20 percent down payment required for a traditional mortgage sometimes choose to get mortgage insurance instead of fronting a 20 percent down payment, keeping the extra cash liquid for closing costs or emergency funds.
Which is Best?
The answer is different for everyone. Obviously putting a bigger down payment is best because it lowers your mortgage amount and your rate. That might not be an option for some as all they can afford is a smaller amount. It also might make sense to keep the extra money in an emergency fund in case costs come up for the home, which they almost always do. Sitting down with a professional to understand your situation is your best route.
Types of Mortgages:
Fixed Rate Mortgages
These are mortgages that have an interest rate that doesn’t change or is “fixed”, for a set period of time, often between 1 and 5 years. It’s easier to manage a budget with a fixed rate mortgage since your payments won’t change during that fixed term. The interest rates for fixed mortgages tend to be slightly higher than other types of mortgages where the rate changes; what you gain in stability, you pay for with a higher mortgage interest rate. Fixed rate mortgages are most beneficial when interest rates are low and expected to rise over the length of the term – although predicting rate increases and decreases are far from an exact science. Five-year fixed rate mortgages are one of the most popular mortgage products in Canada.
Adjustable Rate Mortgages
This style of mortgage is reviewed at intervals and then adjusted based on the current prime rate, the rate at which a commercial bank’s optimal customers can borrow money. This rate adjustment affects both the monthly payment as well as the interest rate on the loan. If you have an adjustable rate mortgage and the interest rate drops, then you benefit from the lower mortgage rate instead of being locked into the higher mortgage rate as you would be with a fixed mortgage. The risk, of course, is that if interest rates rise, then you are on the hook for those increase in payments as well. Adjustments can happen without much notice, and as often as eight times per year. Adjustable rate mortgages are beneficial if you can withstand fluctuation in monthly payments but want to take advantage of lower rates.
Variable Rate Mortgage
This type of mortgage rate also fluctuates with the prime interest rate. With a variable rate mortgage, however, your monthly payment remains the same because the fluctuating amount is the amount of the payment that’s applied to the mortgage principal. A variable mortgage allows you to keep some stability in terms of consistent monthly payments, but also reap the benefits if interest rates fall. Rates are typically lower with a variable mortgage than they would be with a fixed rate mortgage.
Which is best?
For most Canadian’s, the stability of the fixed rate mortgage is attractive. For those who opt for variable mortgages, it is important to have a flexible budget with a well-funded emergency fund. If you are on the edge when making monthly payments, an interest rate hike may cause you to be over budget every month. Again, having your own personal situation assessed by a professional is your best bet.
Types of Mortgage Payments:
A monthly mortgage payment is when your mortgage payment is withdrawn from your bank account on the same day of every month (i.e. on the 1st). With a monthly mortgage payment, you make 12 payments per year. This is the traditional standard for mortgage payments.
A bi-weekly mortgage payment is when your monthly mortgage payment is multiplied by 12 months and divided by the 26 pay periods in a year. With a bi-weekly mortgage payment, you make 26 payments per year. This type is becoming more and more common amongst Canadians.
A weekly mortgage payment is when your monthly mortgage payment is multiplied by 12 months and divided by the 52 weeks in a year. With a weekly mortgage payment, you make 52 payments per year. This method is not as common, but some people do prefer it.
The one major difference between regular and accelerated payments is how the payment is calculated. With an accelerated payment option, you end up making roughly one extra payment a year. It’ll cost you a little more on a monthly basis but will save you thousands in interest and help you pay off your mortgage even sooner.
Which is best?
This one depends on what you can afford on a monthly basis. It also depends on how you get paid. I would not recommend someone who gets paid monthly to do a weekly payment schedule. Also, those with small emergency funds and tight budgets should not opt for accelerated payments. Just because you can pay off your mortgage sooner doesn’t mean you should. You may end up house poor for many years trying to pay off a mortgage sooner. I have also seen people go into debt trying to achieve this goal. Having a well thought out budget should help you make this choice.
Knowing what is best for you isn’t tough, but it does take some thought. Some key takeaways are, always make sure you keep in mind what you make every month and what your financial obligations are. There is a noble goal of paying off your home sooner but remember that comes at a cost. Also, remember that a home is not truly yours until you have completely paid it off. Consistently re-financing your home is not optimal, so make sure you are not leaking money every month and accumulating debt that you must put back into your mortgage. This will only prolong the payment process and eat away at savings for other things like retirement. Also remember this, buying a home is a huge commitment and not one that should be taken lightly. In order to have success with your financial plan, home ownership should augment your plan, not hinder it. Take some time to evaluate your personal situation with the help of an expert before taking the plunge. Doing so could save you thousands of dollars and countless headaches.
“The biggest obstacle to wealth is fear. People are afraid to think big, but if you think small, you’ll only achieve small things.” – T. Harv Eker
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