Fantastic Mortgage rates

If you are in the market for a new home. Or if you have a mortgage with a remaining amortisation that is 5 years or more, you should be super happy this week.

Last week Bank of Montreal announced that they had lowered their 5 year rate to 2.99%. That is really incredible considering that a lot of people don't have variable rates as low as that.

And now ING Direct is offering a 10 year mortgage at 3.99%. Wow!

We have no idea where mortgage and interest rates will be over that long a term. So to be able to lock in your mortgage for a 10 year period at that low rate is just too good a deal.

I remember with envy that in the early 2000s I started off my mortgage at a 5 year rate north of 7%.

New Year

A very Happy New Year to everyone.

So what does one need to do once the new year's eve alcohol and festivities wear down? From a financial perspective, there are a few things you should look at right away ...

1. TFSA: If you have a Tax Free Savings Account, a whole new $5000 in contribution room becomes available as of January 1st. So if you have to dough ... make sure you put the money in the account and let it grow ... tax-free as soon as possible. Even if you do not have money saved up, you can start smaller regular contributions from your paychecks. Pay the TFSA before anything else and you won't miss the money. :)

2. RRSP: Hopefully you have already made your RRSP contributions for the 2011 tax year. If not, the countdown to the deadline starts now. Make sure you do that before Feb 29th to get you tax savings in time for your 2011 return. You could be even more proactive and start contributions for the 2012 Tax year. Of course this means that you need to guess a bit on your RRSP contribution room for the year. But if your income has stayed much the same or grown in the past year, your RRSP room should be at least what it was for 2011. Its never a bad idea to start something safe now and then when you get your Notice Of Assessment, you can always top it up.

3. Mortgage lump sum prepayment: If you have a Mortgage and plan to make a lump sum payment to the mortgage without penalty, Jan 1st gives you a fresh opportunity to do that. Most lenders allow annual lump sum prepayments with no penalty. If you have funds lying around, doing nothing, get them working for you by saving you mortgage interest.

4. Credit card debt: Before you do any of the above, make sure you pay off your credit card debt that you may have accumulated thanks to Christmas and Boxing day shopping. The 19 or 29% interest you pay on your balances will be far greater than any benefit gained from any of the above.

In addition to the above, the new year is a great time to reassess your financial situation, review your plans, and course correct if needed.

Have a Happy New Year!!!

Mortgage Basics

When I first found myself looking for a mortgage, I was a bit confused by all the terms and procedures. I've tried to compile all that I could think of in this post.

Mortgage: This one is simple. It is essentially a loan that a lender gives you that allows you to buy the home. This of course only applies if you are like most of us and do not have all the funds to purchase your desired home outright in cash.

Mortgage rate: The lender will only front you the money for your home if there is something in it for them. So they charge you interest on the amount you borrow from them. The mortgage rate is the rate of interest per annum that you will have to pay for the borrowed funds.

Fixed rate: Most people go with a Fixed rate mortgage. This is the agreed upon rate of interest to be charged on the borrowed funds. This fixed rate does not change over the term of the mortgage. So your interest costs are predictable and the same can be said about your payments.

Variable rate: Variable rate mortgages have an interest rate that can change over the term of the mortgage. Mostly a variable rate will be lower than a fixed rate but that is not always true. A lot of people avoid variable rates because of the uncertainty. Currently interest rates are at historical lows and hence variable rate are low as well. But if the economy improved dramatically say in the next year and rates went up, your mortgage rate would also go up if you went with a Variable rate mortgage.

Open or Closed Mortgage: A open mortgage is one that allows you to pay off the balance of the borrowed funds at any time with no penalties. This provides flexibility in case you need to sell or move to a different lender. A closed mortgage assumes that you will stay with the current mortgage till the end of the term. If you try to leave before hand there will be some "early termination" penalties which typically tend to be around 3 months interest (but could be different). In my experience closed mortgages offer better rates than open and most people tend to opt for those.

Term: The Term of the mortgage is simply the duration of the contract with the lender. It should not be confused with Amortization which refers to the total time you expect to take to pay off the entire loan. The Term comes in various flavours - anywhere from 1 year to 10 year (some can be even longer) but the 3 and 5 year terms tend to be the most popular. At the end of the term, if there is still an outstanding balance on your loan / mortgage, you are free to pay it off without penalties or renew with the lender under new terms or move to a different lender.

Amortization: This is the total anticipated period of time that you expect to take to pay off the mortgage. In most cases it defaults to 25 years. And most people leave it at that. However it does impact your required payments - the longer your Amortization period, the lower your required payments.

Down-payment: The amount of saved funds you must bring to the table for the purchase of your home. Typically 5% is the minimum with some jurisdictions allowing 0% down mortgages as well. With lower down-payments you must also pay mortgage insurance (since the risk of you not being able to pay your mortgage is higher as you have not demonstrated sufficient savings ability) which normally applies if your down-payment is less than 25 20% of the cost of the home.

Appraisal: The lender at times will require that your home be appraised since they do not want to loan you more money than the house is worth. If you want to pay more than what the place is worth you have to do that with your own funds.

Pre-payment clauses: Most lenders will allow you some flexibility in making more payments than are required, thus allowing you to pay off your mortgage faster without penalties. Some will allow you to increase your regular payments by a certain percentage while others will allow you to make lump sum payments that do not exceed a certain percentage of the original mortgage amount in any given calendar year.

Payment schedules: Basic mortgage payment schedules require payments once a month. If you get paid twice a month you can split that monthly payment into 2 and pay it each time you get paid. Most lenders offer "accelerated" bi-weekly or weekly payments. For accelerated bi-weekly payments you are basically paying half the required monthly amount every 2 weeks. However since there are 52 weeks in a year, you are making 26 bi-weekly payments each year and thus making 2 extra payments (essentially 13 months worth of payments in 12 months). This only works if your budget allows it but it does allow you to pay off your mortgage a bit faster.

I can't think of anything else at the moment but if I am missing anything, please ask in the comments and I shall add it here.

Mortgage "good habits"

When we are buying a home, emotions are high. We're excited, already planning the colours of the walls and who gets what room. Its natural that smart financial habits take a back seat.

Here are some of my "good habits" that I hope others can relate to or perhaps learn from.

1. Don't buy the home you can afford but rather the home that you need. - For most people, the first step in the home buying process is a visit to the bank to figure out what they can afford. While its a good to know what you are allowed to spend, isn't it a better idea to first find out what is it that you need?

The first step has to be to assess your needs - the size of your family, plans for expanding the family in the next 3-5 years, do you need a bungalow because of mobility issues, location i.e. proximity to work, transit, schools, shopping etc, lifestyle etc. If you're a couple with no kids (and no plans to have any or they've already left home), you can likely do with a 2 bedroom place. If you've got a baby (or two) on the way, you need to plan ahead accordingly. If you always take public transit, there's no point looking for a home with a 2-car garage. If you have a very outdoorsy lifestyle and all you want from the home is a place to sleep, you likely don't care if there's a basement or a man-cave.

Once you have figured out what you need, the next step would be to figure out what the market is asking for your needs. Never overlook or outright ignore certain areas or kinds of homes, unless there is a valid reason to do so. Hear-say, perceptions are all useful tools but we're talking about big money here so you owe it to yourself to check out all the options.

Now that you know what you need and what it will cost, in most cases you should know whether you can afford it or not. The visit to the bank should simply be to confirm your calculations and to actually get something on a piece of paper that others will want before letting you have their home. Of course the banks will give you way more money than what you need. Resist the temptation to convince yourself to buy more house than you need. Its not like the bank is offering you free money. You still have to pay it back and more importantly you still have to pay all the interest on that extra money. And that extra money will be the last to be paid off and hence will cost you in interest till the very end.

2. Shop around for the best mortgage.
Most people do this already. But they tend to focus on the just the rate. When I am shopping for a mortgage, I am looking at a few other things as well. Here are all the balls that are in play in my calculations ...
- TOTAL interest cost over the life of the mortgage. Based on my financial situation, I prefer to guesstimate how long it would take me to pay off the entire mortgage. I prepare 2 tables - minimum required payments only & aggressive but feasible pay down. That instantly shows me how much I can save in total interest costs over the life of the mortgage and provides good incentive to follow the aggressive scenario. Always keep your eyes on the Total interest cost ... that's the ball you want to watch ... in fact add it to the purchase cost of your home because this is the true cost of your home.
- Pre-payment options. Most banks / lenders will allow you to increase your regular payments up to a certain percentage and / or allow you to make lump sum payments which go directly against principal reduction. All this with no penalties. Some banks will give you either or. Others will give you both but vary in the percentages. Check out the different options.
- Incentives. Are there upgrade dollars in play if you go with a certain lender? Is someone offering cash back? Is someone offering lower interest rates for the first year? In my experience, in most cases, these are simple gimmicks. In rare cases going one way or the other can be beneficial. Maybe if you take the mortgage from a certain bank, they waive various kinds of fees on other accounts you have with them. This could amount to hundreds of dollars per year and could be a definite plus.

3. Budget for closing costs.
Again most people do but some are very surprised. Avoid putting everything you have into your down payment. Once it goes to the bank, its gone and if you need it 2 days after closing, you aren't going to get it. Well not for cheap anyway. I like to keep a good chunk handy and once I have paid off all the closing costs, if I still have money left over, I use the lender's lump sum payment privileges. That way it only costs me a few dollars in interest over the month or 2 that I held on to the cash but it gives me a lot of flexibility and peace of mind.

4. Avoid unnecessary upgrades.
Very few people actually follow this. Its human nature to want what you don't have. But the smart buyer has his eyes on the bottom line. Every single dollar that you add to your purchase price, will get paid off last. As a result, you will be paying full interest on it for the life of the mortgage. So that $5k granite counter top that you sign off for instead of the standard laminate one is going to cost you over $6K in additional interest (at 5% over 25 years). So you're paying over $11K for that granite counter top. Why not get some use out of the standards that you are paying for anyway and replace them when needed. It'll cost you less.

5. Pay off that mortgage as aggressively as you can.
There is nothing sweeter than owning your home free and clear. And think of all the available cash flow you will have when you no longer have to pay the mortgage. Its like you just won the lottery or got a huge raise.

I'll deal with some more specific tricks in a separate post since this is long enough already. But hopefully this is useful itself.

The flawed system

Over the last couple of days, there has been increasing noise about the household debt levels. Apparently, Canadian household debt levels are at the same levels seen in the US just prior to the 2008 recession. Everyone is saying that we need to reduce debt. The Finance Minister, the Bank of Canada Governor, the C.D. Howe Institute ... the list goes on.

So why is it then that we have such liberal credit policies in place?

The interest rates are at amazingly low levels which in turn means that mortgage rates are low as well.

Banks will lend you all kinds of money ... and you don't even need to ask. You sir, are pre-approved for $$$ in Line of Credit, in addition to all the $$$ we are giving you to buy your next house.

Credit card companies are literally tripping over each other trying to get people to sign up for credit cards. And as soon you get one, you're bombarded with an endless supply of "cheques" so that you can max out that credit limit. Its ok if you can't pay off that money coz that only means that the companies will collect some hard-earned interest at 20%.

You can't go to any store today and expect to complete your purchase without being offered their store credit card. "Oh you already have a credit card?? Well ours is nicer. We give you extra $$ in bonus cash. Plus ours is made from the best plastic ever. Its so nice that you won't even know its there ... till the bill shows up."

Looking to buy a used beater car? "Why not go for this brand-new top-of-the-line luxury model that warms and caresses your butt as you juggle your coffee and cigarette and "handsfree" cell phone and eye-liner (wait! that's a separate rant:)). Can't afford it, well we've got just the deal for you. Since you can't afford the car, we'll give you money and the car."

And then the customer is to blame. If the "system" thinks that credit is too "free" ... well "unfree" it. About a decade ago, one needed atleast 5% down to buy a home and the longest amortization available was 25 years. I was shocked when I found out that you could now get one for 0 down and have amortization periods as high as 35 years. A lot of people don't have careers that long. How can anyone in their right mind expect them to pay off their mortgage?

I know there are a lot of people who will hate me for this. But this is what my common sense tells me ...

1. If you cannot show any discipline and save a measly 5 percent of the purchase price of the home you want to buy, you should not be allowed to buy a home.
- Yes some will argue that if they can pay their rent consistently, they'll be able to make their mortgage payments. While that is valid, its not fair to compare rental payments to mortgage payments. Add property taxes, condo fees, snow removal contract fees, hydro, gas and water bills, higher property insurance and a few others that I may be missing. Most people do not factor these costs when deciding between renting and buying. The 5% down is kind of a good faith payment, that shows that you are capable of some sort of savings. Even if you have a big enough income ... if you spend it all, becoming a home owner isn't going to help the situation.

2. If you do not expect to pay off the home in 25 years, you should not buy the home.
- 25 years is a long long time. At a 5% interest rate, on a $200K mortgage, if you just keep making the minimum required payments and the interest remains the same for the full 25 years, you will have paid almost $150K in interest on top of your mortgage amount. This will look even worse when you consider higher interest rates and higher amortization periods. Any appreciation in property will quite likely be wiped out by the interest costs. And then there is inflation and the other costs I mentioned above and very quickly its clear that you are not really ahead relative to if you were renting. Most people overlook the interest costs. And ofcourse the Banks don't want to talk about it ... its what they're after. If you start worrying about interest ... they wont get anything.

3. For 2nd and 3rd and 4th and subsequent properties, the down payment requirements need to be much higher ... perhaps even as high as 50%.
- These "investment" properties tend to mess with the real estate market a lot in my opinion. And if the market drops ... these are the first ones that get off loaded. A family that lives in the home that they own is less likely to walk away from it if its value drops. On the other hand, an investor will see it simply from a profit / loss perspective and would much rather "cut his losses". By making the down payment requirements higher for investment properties, the risk is shared a bit more evenly between the bank and the investor. It will allow fewer speculators in the market and thus perhaps avoid bubbles.

Will the "system" wake up and do the right thing? Time will tell ...