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Managing Your Mortgage
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Jack
and Tita had fulfilled a life long dream of buying their
first home. It was a financial squeeze but by amortizing
the home over 25 years, they were able to buy the house
they wanted. At the end of the first year in their home,
they received their annual mortgage statement. They
were stunned that despite their hefty monthly payments,
they had paid off very little of the principle. They
wondered how they would ever get the house paid for.
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Whether
you already own or are buying a house, townhouse or condominium,
becoming an expert on mortgages will save you tens of thousands
of dollars in interest payments. For many of us, buying a home is
the largest purchase we will make. The generation before us had
the luxury of buying houses and seeing them increase dramatically
in price. Many economists believe that the real estate cycles that
helped our parents’ homes double and triple in value will never
appreciate and double and triple in value will never come around
again, so don’t buy a home thinking it will be your ticket
to retirement. You home will keep you and your family warm and dry,
and hopefully increase marginally in price at the same rate as inflation
but it should not be considered an investment vehicle. Because of
this, you want to be especially concerned about how much money you
are paying in interest.
When I bought my first home I was astounded, shocked really, at
the profit the bank would make from me in interest! I believe in
many ways that mortgage rates are very misleading. Sure, the mortgage
rate may be an annual interest charge of 8%, but is it really 8%
when you have to pay the vast majority of interest charges up front?
Does the bank pay you your profits up front on your investments?
Of course not. In the United States, homeowners can at least deduct
the amount of interest they pay on their home from their income
taxes. Why can’t Canadian homeowners, who also have to pay
huge income and property taxes, get some kind of break as well?
While I would like to see some reforms and more fairness in the
mortgage sector, don’t count on it happening as Canada’s
major banks are making billions of dollars annually and see no need
to share the wealth. I’ve always felt that banks must love
starter homes especially because they hardly ever get paid off.
People move in, make bank payments top heavy with interest, move
out after a few years and let someone else move in and start the
process all over again. It’s as if the banks are absentee landlords.
Every home buyer should have their own mortgage calculator or amortization
tables either in a book or on a computer. With today’s financial
software, you can easily plug in the appropriate figures to see
how much you will be paying in interest over time. The software
available to the public is the same the banks use, so there is no
mystery to the process.
As an example, let’s say that Jack and Tita are going to buy
a house and need a mortgage from the bank of 185,000 dollars. They
negotiate an interest rate of 8.5% (see Alert 2 on negotiating a
better interest rate) and agree to amortize the mortgage over 25
years.
$185,000
mortgage at 8.5 % interest rate over 300 months
= monthly payment of $1,471.
Total
amount of interest paid to the bank over the term
of the mortgage = $256,429.
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If
Jack and Tita made an effort to pay the money back in 20 years,
they would save considerably.
$185,000
mortgage at 8.5% interest rate over 240 months
= monthly payment of $1,588.
Total
amount of interest paid to the bank over the term
of the mortgage = $196,199
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Jack
and Tita’s monthly payment would go up only $117 dollars but
they would save $60,230 dollars in interest payments and be done
with their mortgage five years sooner!
If
they tried to pay it back in 15 years, they would save even more.
$185,000
mortgage at 8.5% interest rate over 180 months
= monthly payment of $1,806.
Total
amount of interest paid to the bank over the term
of the mortgage = $140,061
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If
they paid their mortgage off in ten years, the amount of interest
they would pay would be only 35% of what they would have had to
pay if it were amortized over 25 years.
$185,000
mortgage at 8.5% interest rate over 120 months
= monthly payment of $2,279.
Total
amount of interest paid to the bank over the term
of the mortgage = $88,510
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When
I did these calculations while buying my first home at 28-years-old,
I was determined not to give the bank any more in interest payments
than I had to. My wife and I agreed to try and pay back our mortgage
over 15 years. We stuck to that schedule for three years, however
when along came babies, diapers, strollers and other expenses in
our growing family, it became difficult to maintain that pace of
repayment. An older, wiser colleague at work told me "Pat,
sure you want to pay your house off as quickly as possible, but
if you don’t have money left over for other expenses and to
have some fun, you’ll end up getting divorced." My wife
and I agreed to scale it back through the baby years.
It is difficult to try and put extra money toward a mortgage, but
many homeowners do not realize how much interest they end up paying
the banks  over
the long term. Often when you go in for a mortgage the bank automatically
qualifies you for the 25-year term and makes little effort to inform
you of other options. Why? They want you locked in as long as possible
to get the most money out of you.
If you have no choice but to settle for a long amortization period,
you can still try to make lump sum payments, double up payments
or pay weekly or biweekly. Matching biweekly mortgage payments to
your paycheque is helpful so you don’t end up scrambling for
funds at the beginning of each month. Make 26 payments a year instead
of 24 and resist the temptation to skip a payment when the offer
is made by your bank. It’s pitched as a way to give you more
spending money around the holidays, but it’s just another way
banks can get more interest in the long run.
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