Are you in the market for a new home this spring? If so, it's a great time to purchase a property due to the low interest rates. If you're like most borrowers, however, you don't pay a lot of attention to the mortgage rates posted since you know that this may not be the exact amount you'll be paying. These posted rates do matter though and it's important that you understand why.
Should You Get a Variable-Rate or a Fixed-Rate Mortgage?
If you are looking for a mortgage with a variable rate, you may still have to meet the standards for the posted higher fixed rate to qualify. This is due to the fact that the Canadian government considers these variable rate mortgages as more of a risk factor and is trying to keep their growth limited.
If you're looking for a fixed-rate mortgage you may qualify for the loan based on the actual interest rate that you'll have to pay. This is usually lower than what the posted rate is. In other words, you may end up qualifying for a higher mortgage if you apply for a fixed-rate instead of a mortgage with a variable rate.
Penalties for Ending Your Mortgage Early
If you have to end your mortgage early and the interest rates are going down, the payment penalty will be based on an interest rate differential. In order to come up with the final penalty amount, the bank will often use the posted rate as it was when the mortgage was first initiated and the posted rate when the mortgage was canceled.
On the other hand, if you end up breaking your mortgage when the interest rates are going up, you'll have to pay a penalty that roughly equates to 3 months of interest payments. This means that when you decide to end a mortgage to take advantage of lowering interest rates, you'll end up paying a higher penalty.
How to Protect Yourself From Increased Interest Rates
No one has a crystal ball, but we do know that rates are on the rise. By how much and when is anyone’s guess, but these increases may have a significant impact on homeowners if they are not prepared. The affordable 5 year fixed mortgage that you have now, might turn into a slightly less affordable mortgage at renewal time.
Here are a few tips for people on how they might protect themselves now from increased rates in the future.
Don’t Overspend Or Spend More Than You Need
If you are buying a new home you might feel tempted to borrow as much as you can. When you have all your money in the game you have less options. If interest rates rise that home could become very unaffordable when it comes time to renew.
Use the extended amortization and pre-payment to your benefit – Many home owners are enjoying lower payments by using extended amortizations of 30-35 years. In the case of rising rates, build yourself a buffer, take a 30-35 year amortization but pay it at a 25 year frequency.
Another good way to decrease your amortization and start hammering away at the principal faster is by changing your payment frequency. Instead of monthly payments, choose bi-weekly. On a 35 year amortization bi-weekly payments will decrease the amortization from 35 to 29.2 years.
Also consider doing lump sum payments using tax returns, bonuses or extra cash.
Consider The Future
Consider what increased rates will do to your monthly payment at renewal time. If you are locked into a mortgage for 5 years @ 4% and rates increase by 2.5% your monthly payment will increase by $143. Considering the impact of this increase now my help save you headaches in the future.
Increase Your Payments On Your Variable Rate Mortgage
If you have a variable rate mortgage you may want to set the payments higher than the ultra low payment you are getting now. That way when rates go up, you won’t feel the increase as much.
Keep Track Of Your Other Debts
If mortgage rates go up, so to will the rates on loan and credit cards. Try to pay more than the minimum payment on credit cards and if possible try not to carry a balance. If you get a hold on your other debts now, you won’t feel the pressure when it comes time to renegotiate your mortgage down the road.
Talk To A Professional
Does thinking about increased mortgage rates and trying to make a plan make your head spin? Talk to a mortgage professional about how to put these tips into action. And when it does come time to renew don’t sign the renewal letter without getting a second opinion. Mortgage Planners can either help you negotiate a better rate at your existing bank OR find you a better deal elsewhere. That way you have more money to devote to increased payments or other debt obligations.
The Importance of Posted Rates of Interest No Matter Which Rate You Use
Even if you are not paying the posted rate of interest on your mortgage, this rate can play an important role if you decide to break your mortgage contract early. The penalty that you'll have to pay may be based on the posted rate instead of on the actual interest rate that you are paying and this could cost a lot more money.