How to determine when you will pay more for a mortgage
A nasty surprise awaits some variable-rate mortgage holders on renewal(2018.11.20)
What’s worse than a variable-rate mortgage that keeps getting more expensive as interest rates rise? The answer is a variable-rate mortgage where payments stay the same instead of rising to reflect higher borrowing costs. Static payments mean your lender is using more of your payment to cover your rising interest costs and applying less against principal. The amount of time it takes to pay your mortgage in full – the amortization period, in other words – should decrease steadily as you make your payments. But having more of your payment go toward interest and less against principal slows down the process of paying off a mortgage. Unless you make extra payments, it could take years longer to be mortgage-free. Financial planner Jason Heath has a client who started with a variable-rate mortgage where the amortization period has actually increased over what he started with. “He was a bit surprised, and it caught me off guard, too,” Mr. Heath said. “But when you start actually doing the math, you see that since the summer of 2017 we’ve seen rates go up 1.25 percentage points.” Renewal time is when the cost of paying your mortgage off slower than anticipated hits home. Most lenders use an amortization period at renewal that is based on the number of years you started with, minus the number of years that have elapsed. If you have to get an errant amortization back in line when you renew, expect higher payments. “[The borrower] would have to be prepared for the expectation that the payment could be bumped up quite significantly,” mortgage consultant Sandra Epstein said. The term variable-rate mortgage is an imprecise one. One type keeps your mortgage payments level, even as the actual rate changes. Another type is the adjustable rate mortgage, which is what you should ask for if you’re just now setting up a variable-rate mortgage. Adjustable rate means that every time banks change their prime rate, both the interest rate on your mortgage and your payment will adjust higher or lower. Mortgage broker Steve Garganis says he deals with several mortgage lenders that offer the adjustable-rate mortgage, where payments change in tandem with interest rates. But there are many banks and credit unions that offer variable-rate mortgages with level payments. Mr. Garganis supplied this disclosure from one bank’s variable-rate information kit for mortgage brokers: “The payment remains constant. If rates rise, more of the monthly payment is applied to interest.” The latest Annual State of the Residential Mortgage Market in Canada report from Mortgage Professionals Canada showed that 28 per cent of all mortgages were variable-rate. Four per cent were variable-fixed hybrids and the remainder were on a fixed-rate. Over the past few decades, while interest rates were in decline, variable-rate mortgages offered consistently lower borrowing costs than fixed-rate mortgages. Now, we’re in a rising-rate world and homeowners need to understand the risks of a variable rate. To do that, let’s take a look at a variable-rate mortgage set up five years ago that is now up for renewal. Variable-rate mortgages set up five years ago were based on a prime rate of 3 per cent – with a discount you might have paid 2.5 per cent. Today’s more aggressive discount would get you a variable rate of 2.85 per cent (based on a 3.95 per cent prime), which compares with 3.6 per cent on a discounted five-year fixed-rate mortgage. Whether you go fixed or variable, you will face a higher rate at renewal. Your lender will also look at your balance owing and amortization when renewing your mortgage. If you’re coming off a variable-rate mortgage with payments that stayed put while rates rose, you may find higher rates are being applied against a mortgage balance that didn’t get chopped down as much as you might have expected. You could find yourself paying much more per month post-renewal because of both higher rates and the need to bring your amortization period into line. If you have made a prepayment on your mortgage or you make payments on an accelerated biweekly basis instead of monthly, then you have taken extra steps to eat away at your principal. This will at least partially offset the impact of rising rates on a variable-rate mortgage with level payments. One final word of warning for those holding variable-rate mortgages with level payments: In the unlikely event of a surge in interest rates, your payment may not even cover the interest owing on your mortgage. In that case, your lender will increase your payment to make sure your interest cost is fully covered.(The Globe and Mail, Rob Carrick)
Beware Online Loan Calculators(2019.10.28)
Loan calculators on financial websites often have a default setting that shows the amount, interest rate and payment period for a hypothetical loan. But those default settings—which provide an intuitive example of how the calculator works—could do more harm than good. According to a study published online in the Journal of Behavioral and Experimental Finance in June, borrowers unconsciously could be manipulated into choosing a more expensive loan, depending on the calculator’s default settings. The researchers found that people were almost two times more likely to chose a longer-term loan if their online calculator’s default setting had a five-year loan or longer, compared with participants who had a one-year loan as the default setting on their calculator. Extending a loan even just for a single year can have a big impact on what borrowers end up paying. In the study, which was conducted in Ireland, participants had to pay the equivalent of about $522 extra when choosing a four-year loan over a three-year loan, according to Shane Timmons, one of the study’s co-authors and a post-doctorate research fellow at the Economic and Social Research Institute in Dublin, Ireland. The other authors were Peter D. Lunn, founder of the Economic and Social Research Institute’s Behavioral Research unit and an adjunct professor at Trinity College in Dublin, and Féidhlim P. McGowan, a former research assistant at the Economic and Social Research Institute who is now working on a doctorate.
The study builds upon behavioral-economics research showing that people have a tendency to stay on or close to the default setting and use reference numbers to make choices, even if those numbers are totally random. Researchers have used these insights to encourage employees to set aside more in their 401(k)s or taxpayers to save a certain percentage of their tax refunds. There has been much less research on how defaults influence which loans borrowers choose and how lenders might subtly influence their choices, though previous research from Dr. Lunn has shown that when the size of a monthly repayment is highlighted, consumers tend to choose longer-term loans, but when the amount of accrued interest is highlighted, they pick loans with shorter repayment schedules. The Irish Competition and Consumer Protection Commission funded the study. Before the research began, the commission along with the study’s authors, compared the default setting on lenders’ online calculators with those on independent websites’ loan calculators. They found that lender calculators tended to display longer loans—five years, on average—than those on independent sites, where the default settings typically showed loans lasting a single year. In their study, the researchers gave participants a loan calculator and asked them to search for a €10,000 ($11,170) loan. The 180 participants were randomly put into two groups. One group used calculators with a one-year default setting, and the other group used calculators with default settings of five or more years. Most participants chose to evaluate several loans with their online calculators.
Dr. Timmons had two theories as to why the default setting had the effect it did. First, he says, the calculator’s default setting may have acted as a starting point to compare other loans. Second, participants may have attached meaning to the default setting, seeing it as either a social norm, telling them the most popular choice, or as a prescriptive norm, a recommendation on the best choice. Understanding how people interpreted the default setting could help researchers design better interventions. But for now, consumers might be better off if they make decisions about loans or other types of financial products by using online tools from independent websites that have no prepopulated information in its online calculator. Only when consumers know exactly the product they want to purchase does Dr. Timmons advise going to the lender’s website to shop for a loan.(Toronto Star, Lisa Ward)
Pace of mortgage borrowing picks up, signalling end to real estate lull(2019.10.29)
Canadians increased their mortgage borrowing last month at the strongest pace in more than a year, the latest sign that real estate activity is rebounding from a prolonged lull. The total value of residential mortgage credit climbed to $1.6-trillion in September, up 4.2 per cent from a year ago, according to new figures from the Bank of Canada. The pace of credit growth has increased for seven consecutive months. Prior to that, it had been in decline as various housing regulations went into effect, including a stress test on uninsured mortgages that was designed to cool off higher-priced urban markets.
The uptick in mortgage credit growth is an indicator that lower mortgage rates are starting to motivate home buyers. This year, some mortgage rates plunged as much as a full percentage point from recent highs, influenced by government bond yields that are substantially lower than at the outset of the year. That, in turn, is providing a spark to prices. In the Greater Toronto Area, including both the city and its outskirts, the benchmark home price rose 5 per cent in September to a record high of $806,700, according to the latest figures from the Canadian Real Estate Association. After a tough 2018, which had the lowest number of national sales since 2012, home sales increased by 16 per cent in September from a year ago, according to CREA, which noted that sales climbed in all of the largest urban markets. Canada Mortgage and Housing Corp. expects sales to increase in 2020 and 2021, supported by favourable economic and demographic conditions. The source of mortgage lending is also shifting. Residential mortgage credit at chartered banks increased 4.5 per cent in September from a year ago, the strongest pace in 16 months. Growth had dipped below 3 per cent after the introduction of B-20 regulations in 2018 that imposed tougher qualifying rules on uninsured mortgages. After those rules went into effect, non-bank lending abruptly increased and growth outpaced that of chartered banks, leading to concerns that riskier borrowers were migrating to less regulated lenders. (Non-banks include trusts, credit unions and other institutions, many of which aren’t held to the same rules as chartered banks.) However, non-bank lending growth is slowing as financial conditions ease, and chartered banks continue to account for the lion’s share of residential mortgage credit. “With the Bank of Canada under pressure to continue to provide a stimulative environment following sustained levels of uncertainty, residential mortgage credit growth is expected to remain supported in the foreseeable future,” said Bank of Nova Scotia economists in a research note.(Toronto Star, Matt Lundy)
Mortgage shoppers looking to roll the dice on short-term rates should look at 1 or 2-year terms
When it comes to mortgage break penalties, big banks are often the worst
How to build a credit score that gets you a great mortgage rate(2019.09.17)
Too many people are skipping a simple first step in buying a home – checking their credit score. Credit scores are widely available at no cost these days. And when you do check yours, it’s quite likely you’ll have a good number that is satisfactory to your mortgage lender. Yet a recent survey by the credit monitoring company Equifax found that 60 per cent of people did not take a look at their credit score before going to see a bank or mortgage broker about a home purchase. Actually, waiting until you’re ready to buy is pushing it. The time to check your credit score is when you first start thinking about buying a home. That way, you have time to build your score so it’s in prime shape when you need a mortgage. According to RateSpy.com, a credit score of 650 or more will get you a half-decent rate, 680 or more will improve things and 720 and up will get you the lowest rate possible. RateSpy said one small lender that sometimes has the lowest rates for mortgages with default insurance requires 780 or higher. According to RateSpy, the difference between a lowest possible and half-decent rate might be 0.15 per cent on a five-year fixed-rate mortgage, or about $55 a month if you bought a Toronto home at the average August price and put 10 per cent down. Equifax numbers show that only 14 per cent of credit scores in Canada are below 650 and that 70 per cent are 720 or higher. “In general, Canadians want to stay on top of their financial situation, and that’s reflected in the scores that we see,” said Julie Kuzmic, director of consumer advocacy at Equifax Canada. Your credit score is designed to predict the risk to lenders that you will not repay your debts on time and in full. A growing number of financial players now offer free access to credit scores, including many big banks, the credit card specialist Capital One, the online lender Borrowell and financial websites such as Credit Karma Canada and Ratehub.ca. Credit scores affect much more than your mortgage rate. Ms. Kuzmic said employers are using them as part of their background checks on new hires, and landlords are using them to assess candidates for their rental units. Ms. Kuzmic said the most important factor for building a strong credit score is making payments on time, including minimum payments on a credit card. A single late payment – up to 30 days – hurts young people with short credit histories more than borrowers with a well-established record of paying on time. Be careful cancelling long-held credit accounts or adding new ones, Ms. Kuzmic added. Doing so will affect the average age of your debts, which is a factor in assessing your credit history. Getting rid of a longstanding card can reduce the average age of your debts, and so can adding a new card. Repayment of student loans is reflected in credit scores, and so is your record of paying your cellphone bill. Other utilities – electricity and heat, for example – are not factored into a credit score. Building a strong credit score is one of the arguments in favour of postsecondary students having a credit card, even if they’re not working and earning money. The other reason, incidentally, is that credit cards are becoming essential for ordering goods and services online. The flip side of starting early with credit cards is that a young person can overspend and hurt their credit score with late or missed payments. Ms. Kuzmic said it takes only three to six months to establish a credit score, and a similar amount of time to build up a low score. The ultimate credit score is 900, a level that the vast majority of borrowers will never approach. Conscientious borrowers, don’t take it personally. Credit scores include lots more information than just our history of paying on time. “We tend to think of credit scores like a test result,” Ms. Kuzmic said. “So people who have a 780 feel like, what am I doing wrong? A bank or other lender does not care about a 100-point score different if that 100 points is 780 to 880. You’re in that group? That’s good enough.” (The Globe and Mail, Rob Carrick)
Make sure mortgage math is in your favour(2019.09.17)
Despite early predictions that mortgage interest rates were going to increase, mortgage interest rates have slid downward since last fall and winter. And although the Bank of Canada just announced they are holding the interest rate, mortgage rates could fall again in the not-too-distant future amidst trade war tensions and the need to boost the Canadian economy. So, stay tuned. Lower rates are good for current home buyers, but if you’re like my fiancé and me, having bought in the dead of winter last year, you paid a much higher mortgage rate than what’s currently being offered. Now we’re seriously considering breaking our current mortgage contract and signing a new one at a lower rate. Most mortgage contracts can be broken but at a cost. Here’s what needs to be considered before breaking your mortgage.
The rationale should make sense: There are typically three reasons people break their current mortgage contract. First, rates have gone down and there is an opportunity to save money, as is the case with my current mortgage contract. Second, your financial situation has changed and perhaps you require lower payments or can afford to pay extra or you might simply want greater flexibility in your contract. Third, you are moving to a new home. Other reasons may exist, but they need to make financial sense. The math needs to be in your favour: Unless your mortgage term is up and you are in a renewal period with your current lender, breaking a mortgage has financial consequences, commonly known as break fees, that are clearly described in the fine print of your mortgage contract. Most people don’t read these details, but it’s worth the effort in case you need to break your contract. Your mortgage break fee is calculated using a variety of factors, such as how much time is left on your contract and the interest rate differential between your contracted rate and the posted rate, which doesn’t include discounts. Many lenders follow the three-month rule where the interest that would have been charged over the next three months makes up the fee. But each lender has its own method of calculation. Other fees may also be charged, such as an administration fee, fees to remove the mortgage and potentially register a new one, appraisal or reinvestment fees. Not surprisingly, these fees can add up to many thousands of dollars, and sometimes tens of thousands of dollars, depending on how large your mortgage balance is. So, if you choose to break your mortgage in an effort to save money on interest, the savings need to be greater than the sum of all the fees. For example, if your fees total $5,000, but your savings (after fees) are $6,000, that’s a good deal. If you don’t stand to save anything after the fees are paid, it’s not worth breaking the current contract. Get to the bottom of what you stand to save: Not everyone has the time, or mathematical confidence, to calculate their total costs of breaking their current mortgage, which is where a deeper investigation fits in. Call your current lender and ask them to prepare a report on the total costs to break your mortgage. Then, I would recommend working with a mortgage broker to prepare a variety of mortgage comparisons, with different lenders, where you can see the potential savings after all the fees are paid, of switching your mortgage to a new contract at a lower rate. For a greater understanding of the math involved, check out the federal government’s Breaking Your Mortgage information page. For my fiancé and me, we are down to two final mortgage offers that our broker has presented us with, and we’re negotiating the rates even further. Ultimately, we’ll choose the mortgage that saves us the most money and gives us the greatest flexibility to make prepayments when we have extra money kicking around. We plan to funnel this savings toward our son’s RESP. (Toronto Star, Lesley-Anne Scorgie)
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