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Friday, August 21, 2009

Paying Down Your Mortgage

As September rolls around, my property taxes will rise on my condo. This always makes me think about my mortgage and how I can improve it.

Before I begin, here is a list of TD's mortgage rates. Here are BMO's. Here are Scotia's. Here are Royal Bank's. Here are CIBC's. Here are ING Direct's.

Fixed vs. Variable - a Fixed mortgage is a mortgage where the interest rate is locked in for a set amount of time. If you get a five-year fixed mortgage, with a term of 25 years, you pay the mortgage over 25 years, but the interest rate will stay the same for the next five years. The advantage to this is that when rates are low (like now), you can lock in a nice low rate for a relatively long time. These rates are mostly on average higher than a variable rate mortgage. A variable rate mortgage is generally prime plus a percentage (now most banks have prime +0.4%). Historically there have been far better deals with variable rate mortgages, but if mortgage rates shoot up, you can end up paying more (although this rarely happens). Your payments will not increase until the interest that you are charged is more than your payments.

Open vs. Closed - An open mortgage is a loan where you can make extra payments (or increase your regular payments) with no penalty. A closed mortgage you have your payments and you cannot increase them or make extra payments without paying a penalty. The interest rates on closed mortgages tend to be lower.

What You Can Do To Pay Down Your Mortgage More Quickly - The harsh reality of mortgages is this: if it takes you 25 years to pay off, you will be paying more in interest than the value of your house. A quick example, a $200,000 mortgage at 5% over 25 years (with monthly payments) charges 1169.18 per month, which is a total payment of $350,754 or $150,754 in interest!

Pay A Big Down Payment - You can get away with putting down only 5% of the value of your home according to the Canadian Mortgage and Housing Corporation, if you pay less than 20% of the value of your home you must take out CMHC housing insurance which is added onto the principle of your house. In order to help people with this, if you have RRSPs take advantage of the First Time Home Buyers Plan where you can withdraw up to $25,000 from your RRSP to go towards the purchase of your home. This money must be repaid back into your RRSP over 15 years.

Get A Lower Interest Rate - feel free to renegotiate with your mortgage company (or another company) when you hear that interest rates drop. If it is financially beneficial to you to switch mortgages because rates fall, then do it!

Pay Your Mortgage Whenever You Get Paid - if you get paid once a month, then it is fine to make monthly mortgage payments. But if you get paid every other week, why would you only pay your mortgage at the beginning of the month (other than habits from renting). The cost savings can be tremendous because of the savings in interest. If you use my previous example of a $200,000 mortgage over 25 years at 5%, the bi-weekly payments drop to $539.32, saving you only $200 over 25 years, but you have lowered your payments as well!

Each Time You Get A Raise Increase Your Payments - This is what I do. Since I have other loans on top of my mortgage I don't do this as aggressively as I should, but I will describe my scenario. I will get my property tax increase, which goes directly to my mortgage. Let's say it goes up $10 (as it did last year), I will then top up my mortgage $15 (for a total increase of $25 each pay). Since I do this when I get a raise, I don't feel the pinch at all! By doing this last year (I haven't run the numbers this year because I don't know what my increases will be), I saved 2 and a half years on my mortgage!

If you have an open mortgage, make a lump sum payment - If money falls into your lap (be it tax returns, inheritance, good fortune at work), putting down a lump sum payment goes right against the principle of your mortgage. As described previously, I work summer school in the summer and always put a few hundred bucks towards my mortgage extra.

Finally a word on purchasing a house and how you know if you can afford it. My recommendation is to take whatever you are paying for your current rent and double it for the next six months. Lets say you are paying $900 in rent. Take the extra $900 and save it towards your down payment for the next six months. If you are able to do this, you will be able to comfortable afford your house and there will be no pinch. If you are unable to do this (or hope that your mortgage and insurance and utilities and all that will work out to about the same as renting) you probably aren't ready for home ownership yet.

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