Mortgages in Retirement
Earlier this month I wrote about prepaying your mortgage as it is good for your financial health. Coincidentally Royal Bank came out with athat had some very disturbing results.
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A third of older Canadians with a mortgage will carry debt into their 70's
This is not the way to spend your "golden years." A 2011 CMHC report revealed that 75% of new home buyers intend on making paying off their mortgages early. Hopefully the younger Canadians can do without the new vehicles, big screen TVs and bi-annual trips to Mexico and follow through on paying their mortgages off early.
Prepay Your Mortgage – It is good for your financial health.
I have been an advocate for prepaying your mortgage rather than investing for a few years now. One of the main reasons for this is it the best guaranteed after tax, risk free return you will achieve is paying down your mortgage.
A recent report by the Certified General Accountants Association of Canada reaffirms this and goes into a little more detail.
Please keep in mind that everyone has unique circumstances where prepaying their mortgage may not be their best option. One such situation is employer matched RRSP contributions. If your employer is matching you dollar for dollar it will be impossible to beat an immediate 100% return on your investment.
Mortgage Rate Game
Banks like to play what I call the Rate Game. Banks have a posted rate, various other advertised and special rates. I use the Alberta Treasury Branch as an example, but all banks play the Mortgage Rate Game. As of today has a posted 5 year fixed rate of 5.59%, an extreme discount rate of 4.19% and are advertising 4.39% at one of their branches. On top of this is extra discretion at the branches for lower rate. This is very confusing for the average consumer.
When shopping for a mortgage you have do to your due negligence. While 4.19% is a competitive rate 3.89% is readily available right now. No doing your due diligence can cost you, but how much? The following compares the total interest paid on a $300,000 mortgage over a 35 year term with the difference fixed rates. All calculations are made with the same monthly mortgage payment amount to eliminate any time value of money issues.
5.59% - $378,788
4.39% - $191,145
4.19% - $181,151
3.89% - $157,386
As you can see a small difference in the rate over the life of a mortgage can cost you tens of thousands of dollars.
How do you avoid playing the rate game? Call your bank and ask for their "best rate." Then do some research online and talk to a mortgage broker and let them find you their best rate. Whether you use your bank or a mortgage broker ensure that the mortgage has features that meet your current and future needs. I will have an article on this in the near future.
The Truth About Refinancing Your Mortgage
There are many resources available instructing home owners that when interest rates go down it is beneficial to refinance your mortgage. Unfortunately, not all of the facts are explained, and in many instances the lure of the lower interest rate and lower monthly payment while very attractive, can be quite deceiving.
One such resource is the online mortgage calculator. These calculators generally explain two things about your mortgage if you refinance. Firstly, how much you will save over the life of your mortgage, and secondly, how much you will save monthly.
One such calculator appeared on three different sites that claimed you could save over $78,0000 in interest on your $300,000 mortgage if you refinanced it from 6% to 4.25%. The payments were actually lowered by $283 a month. This appears to be an incredible savings until you look at all of the facts. A closer look will reveal that these calculators are very misleading. The calculator on all three sites asks you to input the penalty amount and closing costs that will be incurred when refinancing. Two of the sites go on to explain that these numbers are not used in the calculations and one fails to mention this fact completely.
When you sign your mortgage it is a contract for the term you select. The lender expects to get that rate of interest from you during the entire term. If you break the contract before the end of the term the bank will penalize you for any interest that they have lost. The greater of the Interest Rate Differential or three months interest is generally charged when you break your mortgage contract. The IRD is normally calculated by determining the difference between a lender's posted rate at the time your mortgage was signed, and the lender's posted rate for a term closest to the time remaining in your term. Lenders charge this penalty to ensure they are not losing money if you refinance your mortgage before the end of your term. Although this IRD calculation is common practice among lenders polices do vary. You should always contact your lender to get an exact penalty amount.
Another flaw with these online calculators and the numbers they project is that they are basing your interest saved on the full amortization of the mortgage. This is deceptive. In the example used above, you will still need to renegotiate your current 6% mortgage at the end of its term, just like you will still need to renegotiate the new 4.25% mortgage at the end of its term. These calculators assume that you will always renew at the same rate which is highly improbable. You will not save money refinancing your mortgage this way. If you have a need to lower your monthly mortgage payment you can do so by refinancing, but you will not come out ahead. You would be far better off consolidating your high interest debt during the refinancing of your mortgage. It is then possible to substantially lower your total cost of borrowing.
If you have equity in your home refinancing to pay off high interest debt could very well save you thousands of dollars. There are also plenty of advertisements showing that consolidating your debts can save you a great deal of money every month. Sounds like a good idea, right? Not so fast. Ensure your banker, or broker is fully explaining the savings found by refinancing. Work with a mortgage professional who can analyze your debt and take the current balances, interest rates and payments of all of your debts and project what your total debt will be in 3 or 5 years with your current mortgage. Compare this to refinancing and paying off all of your high interest debt. There are four options to look at:
1. Increase your monthly cash flow by having your current projected balance and your refinance balance the same after a 3 or 5 year term This will leave you with the same amount of debt, but a lower monthly payment.
2. Lower your total debt by keeping your monthly payment commitment the same with your mortgage and all other debt payments included. This will not free up any cash on a monthly basis but your interest savings at the end of your 3 or 5 year term will be significant.
3. A combination of increasing your monthly cash flow and reduction of the total amount owed at the end of the 5 year term. This will provide some instant gratification with lower monthly payments while reducing the total amount owed at the end of your term.
4. Extending your amortization period to the maximum 35 years to lower your monthly payment as much as possible. This should only be done when lower monthly payments are absolutely necessary as the interest costs will be significant.
Everyone has unique financial situations, short term and long term goals. Find a mortgage professional that you are comfortable with and fully explain your short term and long term goals. Your mortgage professional will be able to fully explain the outcome of refinancing your mortgage and find a mortgage that meets all of your needs. If you do not fully understand how your mortgage professional is arriving at any amounts ask him or her to explain in detail. If you still do not understand, ask again. Hopefully they are not using an online calculator.
New Mortgage Complete
We received the papers from the lawyer today for our mortgage refinance and worked with the numbers. I am pleased to say that the transaction cost us nothing. Actually, we saved about $933 over the remainder of our term including the penalty and legal fees. How is this possible you ask? Well the first factor was we locked a rate in after the first jump in fixed rates. By the time the deal closed fixed rates had jumped a bit more reducing our penalty. We would have done better if we would have locked in before the first increase but I am happy with the result. The second factor was that we were able to get our penalty reduced by $1168.48. This took a couple of phone calls and some explaining to our lawyer, but it in the end it was reduced. Check out the Original Discharge Statement and the Revised Discharge Statement. I removed the personal and lender information from the statements. I am curious to know what the asterisk represents internally to the lender. If you want to know how we saved this money, purchase my soon to be available ebook, The Mortgage Reduction Guide.
Saving money by changing lenders was a perk, but not the reason we chose to move our mortgage to National Bank. National Bank has an All in One Product that we felt would better suit our needs and save us some interest costs. I rarely recommend products on my blog, but this one impressed us so much that I believe it is worth mentioning.
In the next couple of weeks I will show you how we intend on saving money using this product and how you may be able to as well. Due to the structure of the account I am also going to have to change the way I track our Mortgage Pay Off Progress. I am bouncing a couple of things around, but I have not decided exactly how I will track this. I may add a line for Net Worth to the mix. I have updated it to reflect the new mortgage amount and interest paid. To properly reflect the cost of the switch I have included the penalty and the legal fees into the interest costs. These number will change quite a bit by June or July when we consolidate some accounts and no longer have money idly sitting around.
Original Balance: $316,000.00 (Jul 2008)
Current Balance: $238,836.86 (May 2010)
Total Payments: $108,907.77
Total Interest: $31,137.38
Projected Interest Saved: $270K +