MORTGAGE PAYMENT MYTHS
It` s time to clarify a few things about mortgage payments. Increasing your mortgage payment is always a good idea, but not necessarily for the reasons you may have been led to believe. Additionally, you may be choosing your payment frequency for all the wrong reasons.
The majority of your interest costs are in the first seven to 20 years of your mortgage. In general, the interest portion starts at approximately half of your payment when starting from a 25year amortization and decreasing incrementally from there. Amortizing a $ 200,000 mortgage over the 25 years, using a five- year rate of 2.69 per cent, would result in a mortgage payment of $ 915. The interest portion of that payment starts at $ 445 per month and ends up at $ 380 by your 60th monthly payment. If that seems crazy, it’s because it is.
Even at such a low rate, the interest is still almost half of your monthly payment. By the end of your five years, you will owe close to $ 170,000. If you could budget another $ 85 a month and make your payment an even $ 1,000 you would shave three years off your amortization and you would owe closer to $ 164,000 at the end of the five- year term. Your total interest cost difference would be approximately $ 500 for the term, which isn’t a lot of savings.
All things remaining equal, in the next five- year term you would save $ 1,000 in interest and have your mortgage down to $ 123,000 ( versus the $ 915 payment with which you would still owe $ 135,000).
You will only really notice a significant interest savings 12 to 15 years into your mortgage. By that time, rates will have changed and you may have already remortgaged or increased your mortgage for a newer house. But using the $ 200,000 and having the rate and payment the same for comparison purposes ( in reality this isn` t always the case) you would save approximately $ 9,600 over the 25 ( 22 ) year period, or $ 384 per year.
I believe the key lesson here is that it` s important to update your budget as your lifestyle changes and your income increases throughout the lifetime of your mortgage.
Adding $ 85 in the beginning won’t amount to much, but adding $ 85 or $ 100 in the next term of your mortgage will prove just a little more worthwhile and certainly will help you pay it down faster.
The second myth to debunk is your mortgage payment frequency. When it comes to your mortgage payment it doesn’t matter if you pay bi- weekly, monthly, semimonthly, or weekly. Consumers often misconstrue the fact that paying bi- weekly is better than monthly. The fact is the frequency of payment is nothing more than a budgeting tactic.
Many people like to have their mortgage payment coincide with their income. This is an excellent strategy, but if you really want to pay your mortgage down faster, then set your payments at an affordable amount — over and above the minimum — and it will be reflected in a lower amortization regardless of your payment frequency. You don’t necessarily have to accept the maximum amortization and minimum payment, and a little sacrifice now will make you mortgage- free sooner as mentioned earlier. Some clients choose to pay monthly, even if they are on a bi- weekly pay schedule. This can be helpful in those months that you receive an “extra” pay due to the dates upon which you receive your paycheques.
At the end of the day, your home is your asset; it is an investment and you can treat it like a savings account. Increasing your payment is essentially a forced savings plan that is far less accessible than any other. It can be drawn out later, if necessary, but it is harder to do so, making it less likely that you will.
The payment frequency is a personal choice but it won’t necessarily save you money or pay your mortgage faster. To achieve this, you will have to rely on clever budgeting and the advice of a keen adviser.
Dylan Nose, a mortgage broker, writes a regular column for the Ottawa Sun.
... It’s important to update your budget as your lifestyle changes and your income increases throughout the lifetime of your mortgage.