Sunday, June 18, 2017

Beginner's Guide to Mortgage



Hi, today I am going to talk about mortgage and things to consider when getting a new mortgage. Since my near term goal is to pay off my mortgage within three years, I figure it only make sense to do a post about mortgage. OK, so what is a mortgage? It's a fancy term for a loan to allow you to buy a house, meaning you are borrowing money. Mortgage is big business and banks love them. Let's just think about this, when you get a mortgage, you pretty much are sharing ownership of the house with the bank since they in theory are buying the house for you. In return you pay interest and you assume almost all the risk for that property. There is a reason why you must have home insurance on your home or else the bank will not give you the loan. If you stop paying your monthly payments then the bank will come and evict you from the house, this is known as foreclosure. Intro asides, lets get into the process of getting a mortgage.

1. Buying A House
You found a beautiful house that you like, and for argument say that it is $300,000. Using this lovely tool by ratehub.ca we can see how much mortgage we need based on how much money we have saved up for down payment.
Comparison of down payment amount.
Let say you've been saving for a while and can afford to put 20% down payment therefore you don't have to pay for the CMHC insurance (This is a Canada thing). You either have already gone to the bank for a pre-approval or you now go to the bank and ask them for a $240,000 mortgage. You'll have to give them info of the property you just purchased and proof of income (just to make sure you can pay them back). Banks will take your monthly income (gross), so before tax and other deduction, and check what percentage of that will be going towards debt payments. They want to keep that percentage below 40%. Meaning, if you make $5,000 a month then your total debt payment(credit card, loans, car payment) should be less than $2,000. In Canada they have recently implemented a rule that forces lender to do a stress test before they can approve your mortgage. What this means is that during that approval process, they will calculate your monthly mortgage payment at a higher interest rate (~4.64%), and use that number to check if you still below the 40% mark. If you pass all the check then they will give you your $240,000 mortgage.

2. Mortgage Terms
During this whole getting a mortgage process you'll have to consider a few things. The terms for your mortgage, this is quite important, this is basically deciding how long you want to be on contract with the bank and the terms of that contract. Think of it like this, when you get a cellphone plan most of us will be on contract for a certain amount of time with that cellphone company. Mortgage is pretty similar, you negotiate all the condition and then sign on for a set amount of time.

  • Interest Rate - Mortgage interest rate in most banks are based off something call the prime rate which usually follows the overnight rate from Bank of Canada. So when you hear on the news that the interest rates are going up, that usually refer to the overnight rate from Bank of Canada. Regardless, the lower the rate the less you pay in interest every month, which means lower monthly payment. Then there is the fixed rate and variable rate. Fixed rate means that your rate will stay the same for the length of the contract. Variable rate will constantly be adjusted based on the current prime interest rate.
  • Length - This is how long your contract and all the terms in it are good for. 
  • Open vs Closed - Open mortgage means you can pay off the mortgage anytime you want without incurring a fee. The catch is usually a higher interest rate, however this option is good if you think you are going to sell your house or you know you'll have a large sum of money coming your way. Closed mortgage is the opposite, you will be given specific condition on how much extra you can pay ever year and a penalty if you decided to pay off the mortgage early. This is to protect the bank and make sure they get the interest they were promised. 
  • Terms of Payment - Two basic things to look at when shopping for a mortgage are how much can you repay every year and how much can your monthly payment be increased by. These two things will be important if you are considering the pay off your mortgage faster sometime down the road. The more flexible it is and the higher the amount the better.
Just remember that when picking a mortgage, find the one that suits you and don't try to out smart the bank. They have a lot of smart people working for them to make sure they'll not get rip off. It doesn't matter what the term is, they'll still make money off you.

3. Mortgage Payment 
You have your mortgage approved and have moved into your new residence. Suddenly, you realize how much interest you are paying every year and how long you'll be in debt for. Let's face it, nobody likes giving their hard earn money to the bank. You start thinking, how can I not give my hard earn money away. There are a few simple things you can consider if you want to drastically reduce the amount of interest you pay and the overall length of your mortgage. 

Frequency of Payment - There is three frequency that most bank offers. Monthly, Bi-Weekly and Weekly. Lets break these down to the number of payments annually to show you the difference. 
  1. Monthly - 12 Payments, 
  2. Bi-Weekly - 26 Payments (13 Months), 
  3. Weekly - 52 Payment (13 Months)
As you can see that you actually make one extra payment every year by switching to a Bi-Weekly payment frequency. If you select "Rapid Bi-Weekly" payment options, what the bank do is take your current monthly payment and divide it in half. Although you make an extra payment every year, this not affect your payment increase limits nor your early repayment limits. Some banks allow a 100% payment increase, so if you do that with rapid bi-weekly you can make a big dent in your mortgage. By doing so, you'll bring your 25 year mortgage down to about 11 years. TD Bank has a nice little tool that lets you compare different payment frequency. 

Look at the difference in Principal and Interest between the three.

This graph shows the difference of Monthly vs Rapid Bi-Weekly vs Rapid Bi-Weekly(100% Payment Increase)

Early Repayment
 - Usually in your mortgage contract it will state how much you can payback every year without incurring any penalty. My bank allow me to pay back 15% of my original mortgage amount. So in our example, 15% x $240,000 = $36,000. Remember this amount will go directly towards principal. In the above rapid bi-weekly example, if I paid $5,000 annually, I can shave off 8 years off my mortgage, bringing it from 23 years to 15 years. If you don't believe me, just go play around with the TD Bank tool and see for yourself.

Conclusion
If you are thinking about buying a house I hope this little guide will help you out when shopping for a mortgage. If you already have a mortgage hopefully this post gave you some tips on how to pay off the mortgage faster. There is no real secret for paying off your mortgage faster other then put as much money as you can into it and save huge on interest. Just think of that amount of flexibility you'll have once your mortgage is paid off, you no longer "MUST GO TO WORK" in order for you to have a place to live. That's not completely true cause tax and upkeep, but you get the point. 

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