Turns out 2015 wasn’t the year for rising interest rates, in fact we ended up having 2 interest rate cuts. With rates being so low and expected changes to the Home Buyer Plan, many Canadians might be ready to buy in the new year. Low interest rates can be a bit deceiving since home ownership may appear affordable when you’re looking at just the monthly payments.
What astonishes me is that how many people potential homeowners don’t understand how mortgages work. They know that you need one to purchase a home, and that it comes from a lender, but beyond that, many people are absolutely clueless. They don’t really understand what the difference between mortgage amortization and term are, all they focus on is what their monthly costs will be.
The mortgage amortization and term you chose directly affects your payments so why wouldn’t you want to know what they both are?
The mortgage amortization is the length it will take you to pay back your loan. Many people these days choose a 25 year amortization since it offers lower monthly payments, but that also means you end up paying more in interest. If you choose to amortize your mortgage for less years, you end up paying more every month, but your debt will be cleared much faster.
To qualify for a mortgage you need to have at least 5% saved of the purchase price as your down payment. Some lenders have been willing to loan that 5% to potential homeowners, but if you can’t even save that small amount, do you honestly think you’e ready for home ownership?
If you have a 20% down payment, then you qualify an amortization as long as 30 years, but again that longer amortization means more interest payments so it doesn’t exactly benefit you. What’s the points of saving 20% and then paying a ton of interest charges over 30 years?
With interest payments being so low, many people are in no rush to pay down their mortgages choosing to invest instead. This is certainly a good strategy if you’re a disciplined investor, but many people have maxed themselves out so they don’t exactly have any extra income to invest.
Mortgage term refersto the length of time you agree to pay back your amortized loan. It’s sort of like a short term contract you set with your lender, so your amortization might be 25 years, but your term can be anywhere from 1-7 years.
With interest rates being near all time lows, many people are choosing to go with 5 year fixed terms. Shorter terms are available at an even lower rate but you’re only guaranteed that rate for that set period of time. Taking a longer term will guarantee your rates don’t go up assuming you took a fixed rate mortgage.
What many people fail to understand is that once your term is up, you need to negotiate a new loan from your lender. Those low interest rates you’ve been enjoying will almost definitely be higher in 5 years, so I hope you’ve budgeted accordingly. Some people are so desperate to become homeowners that they forget about the long term costs.
Home ownership is not something you should get into just because rates are low. It may seem affordable on a monthly basis, but have you considered all the extra costs of life such as having kids and saving for retirement? Lenders don’t care about how you’ll be afford anything else, they just care about you making monthly payments and they’re more than happy to lend you more than you can realistically afford. Take the time to learn about all the costs associated with owning a home so you’re well informed when you’re ready to buy.