For many, buying a home, is one of the most important, and maybe even rewarding financial decisions you’ll ever make. But it’s also one of the most expensive. Mortgage companies today, offer plenty of options to pay down your your mortgage faster. You can increase your mortgage payments, make lump-sump payments, or change your payment frequency.
Another option often touted, is to shorten your mortgage amortization, but should you? Yes, your amortization affects how much your mortgage is going to cost. Typically, the longer it is, the more costly it is, as you’ll be paying many more years of added interest. But not always. What if you took on that longer amortization, but paid it off just as quickly? Sometimes a longer amortization can give you the flexibility you need in an era of rising house prices.
A new era in housing
Although the Canadian housing market has seen some cooling as of late, housing prices still seem to be edging higher. I was surprised, this summer, to see by how much that home prices have risen in our area. When I saw a ‘for sale’ sign on a home a few doors down, I had to peek and couldn’t believe the prices. This semi-detached, which showed a lot worse than ours was selling for $479,500. An almost 40% increase, from our original house purchase cost five years ago. Mind you, it did have a finished basement. But upon looking at similar houses in our area, even those without finished basements were fetching in and around the same value.
As a short history of listings in my neighbourhood, in late 2009, one sold on our court (or was listed), for $369,000. In the summer of 2011, one went for $399,000. Thirty thousand dollars increase in one and half years – may be reasonable for these type of homes and this area, but $80,000 in the past year? Normally one would chalk to this up to good fortune, but I just couldn’t see this sustaining itself. This is your average first-time home buying neighbourhood. Not to mention, average salaries haven’t increased that much.
To top it off, last July, the Canadian government announced that all new mortgages would return to having a maximum amortization period of 25 years. When I bought, I believe they were offering 40-year mortgages. Crazy, I know. But although this seems like a good move for the government to ‘reign in on borrowing costs’ by lowering the maximum amortization period, it’s made housing quite unaffordable for the first-time home buyer. House prices alone are high, then you factor in a 25-year mortgage amortization, this is what you’re looking at.
So in my little neighbourhood, if you took a $475,000 mortgage, minus a 5% down payment (not uncommon among first-time buyers), that would bring it down to $451,250. On a 25-year amortization that house will cost you $2133.21 a month just for the mortgage payment alone! What worries me is that young folks are snapping these up just to “get in the market”, but are they stretching themselves too thin? I think so.
Had it been today, I probably would not have been able to afford this house. I do have a confession to make: I was one of those who held one of the 35-year mortgages. Now let me explain. I didn’t take on a 35-year mortgage, with the intention of taking 35-years to pay it down. My intention was always to pay down the mortgage in 15 years. And in fact after signing the 35-year mortgage, the next day I got on the phone and switched my payment options to accelerate my payments.
So why did I take on a 35-year mortgage then? One word:
Everyone thinks they’ll just buy a house and pay it off quickly. I remember that was a common sentiment amongst my friends who bought around the same time as I did. Or that in five years, we’d be moving on to the next house. Ya, you can count me in on that one. But you don’t truly realize how expensive houses can be to own and maintain until you step foot in that door. And then life happens. You have a child, your car breaks down, your roof has a leak, etc. So while my original goal was to have it paid off in 20, it’s slipped to a little over 22 years total now. But I’m completely comfortable with my situation.
You never ever want to stretch yourself so thin. What were to happen if you lost your job tomorrow? Would you be able to carry the mortgage? At the time I was thinking, if I lost mine today, I would easily be able to revert my payments back to the 35-year. Which would mean my $800 bi-weekly payment would shrink back to about $650, a savings of approximately $300 a month, in an emergency situation. So the extra CMHC mortgage loan insurance costs for carrying a longer amortization at the time (0.20% for every 5 years beyond 25), were well worth it to me.
You may say, what’s the difference whether you pay it off, as an example, a 25-year mortgage in 15 years, vs. signing up for a mortgage with a 15-year amortization? Well, when you sign up for the shorter 15-year amortization on your mortgage, you’re essentially increasing your regular payment amount. Think of a regular payment as the minimum payment amount you have to pay each month (or bi-monthly) to your mortgage company. With a longer amortization, your minimum payment can become smaller – if and when you need it. I’ve since renewed to a shorter 25-year, but with a little over 17 years left on my mortgage, I’m still retaining the flexibility.
But since there are no more (new) 35-year mortgages offered, you’re probably thinking why am I talking about lengthening amortizations when many can barely afford a 25-year amortization? Well if you can barely afford a 25, you may want to consider holding off until you can ‘afford’ to pay it at a 20-year rate and then consider taking out a mortgage for a 25-year.
Look, I’m not hear to tell you to stretch out your mortgage for the sake of getting lower monthly payments, it’s about added flexibility. Because you never know what can happen, but it never hurts to be prepared.
* Of course, always consult with a mortgage advisor first about your situation, and whether your mortgage company would be able to accommodate this, or other flexible options.