Getting ahead with low mortgage rates
Posted on Apr 9, 2017 in Mortgage Market Updates and News
It's no secret we've been going through an extended period of unusually low interest rates. While on the surface it seems great for buyers and people looking to refinance their mortgages, there's a 'dark side' if you will, to what the past few years have created. In my career as a mortgage broker in Port Alberni, I work with a lot of first time home buyers. Likely because I'm fairly young :) I tend to attract younger clients. The concerning trend I've seen over the past few years is more and more people who think these rates are normal. Why is that concerning??? Well, a good chunk of people buying homes today (not my clients) don't fully understand the mortgage process. They either don't think about what happens at the end of their 5 year term, or don't realize and account for the fact that rates could be substantially higher when they go to renew their mortgage. People are increasingly often trying to buy to the maximum of what they can afford, while concurrently not working in jobs that tend to have increasing incomes. So when rates begin to increase, and people's 5 year mortgages mature, we could have a lot of people surprised, and possibly not able to afford, their new mortgage payments.
The good news? The Federal Government recently addressed this issue by enacting rules that created a 'qualifying rate'. The qualifying rate means we have to calculate the mortgage people can qualify for at a higher rate (a more traditionally normal rate) than what they will actually be paying on their mortgage. Currently the qualifying rate for a mortgage with less than 20% down is 4.64%. Typical mortgage rates right now are substantially lower at around 2.5% for 5 year fixed rates.
So how can you take advantage of unusually low interest rates? Make your mortgage payment based on the qualifying rate (4.64%), rather than the contract rate (2.5%). This of course doesn't change the actual rate you're charged on your mortgage (still the very low 2.5%) but it allows you to get used to a payment that is more inline with normal expenses for a home in your pricerange. You'll pay your mortgage balance down faster, and also be comfortable with a higher payment if rates happen to increase during your 5 year term and you end up renewing at a higher rate.
Here's an example of how you'll save:
Mortgage amount: $250,000
Interest rate (5 year fixed): 2.5%
Amortization: 25 years (meaning it will take you 25 years to pay off your mortgage)
Monthly payment: $1120
To qualify for this mortgage you would actually need to be able to afford a payment of $1403/month (based on the 4.64% qualifying rate).
If you made your minimum payment ($1120/month) on the above mortgage, you'd end up with an outstanding balance after your 5 year term of about $211,500. If you increased your payment to the payment you need to be able to afford to qualify for the mortgage ($1403/month), your outstanding balance after 5 years would be about $193,500. This puts you $18,000 ahead on your mortgage and sets you on a path of paying your mortgage off in 18 years (if you continue with increased payments) rather than 25 years.
Have questions about your mortgage? I'm happy to help.