Plenty of factors to consider when buying a home

Anyone making mortgage payments has become nicely accustomed to ultra-low mortgage interest rates over the past decade.

In the second half of 2013, interest rates began to creep slightly higher. Then, rates eased back downward again.

How would you cope if your mortgage interest rate rose by one or two percentage points? Let’s review some of the most basic mortgage concepts to understand what options are available for making mortgage payments.

Down payment

You can buy a house with a down payment as small as five per cent. But a down payment of 20 per cent or more would be more prudent if interest rates were to rise.

A prospective first-time homeowner can accumulate a down payment by making tax-deductible contributions to an RRSP and then take $25,000 as a Home Buyers’ Plan (HBP) withdrawal.

Default insurance

If you don’t have at least a 20 per cent down payment, you must pay the premium for CMHC mortgage default insurance, which adds up to 3.15 per cent to the cost of your home purchase.

Mortgage types

There are two types of mortgages — open and closed. Most people choose closed because the interest rates for closed mortgages are about two per cent lower than for open mortgages. For someone with a looming job transfer or separation, for example, who may have to sell their home soon, an open mortgage is appropriate since there would be no prepayment penalty for paying off the entire mortgage.

As you know, interest is the largest component of your mortgage payments in the early years. Only a small part of the payments goes toward principal.

What if you receive an unexpected cash windfall from an inheritance or a bonus paid by your employer? Pay off your high-interest consumer debt first.

Next, consider paying down your mortgage. Even if you have a closed mortgage, you can make an extra lump sum mortgage principal prepayment of typically up to 15 per cent once per year on the anniversary of your mortgage.

Amortization period

The amortization period is how long you expect to repay your mortgage. There is a 25-year limit if you have a high-ratio mortgage (which requires CMHC insurance). There is a 35-year limit for an uninsured conventional mortgage.

Try testing different amortization alternatives using an online mortgage payment calculator. You will see the trade-off.

Taking longer to repay your mortgage makes your total mortgage interest cost much higher.

Is it worthwhile to lengthen your amortization schedule by 10 years to trim a couple of hundred dollars off your monthly mortgage payments if that increases your cumulative total interest costs by $50,000 or more?

Mortgage term

When your interest rates are fixed for one year, you have a one-year mortgage term and you will have to renew your mortgage at a different rate at the end of the one-year term.

Rates that are fixed for a five-year term are normally higher than one-year term rates but, at least you know exactly what your payments will be for those five years. Predictability is especially important when you cope from paycheque to paycheque with no emergency cash cushion to fall back on.

Could you afford a $150 increase in your monthly mortgage payments, for example, if interest rates do rise by one per cent the next time you renew your mortgage?

Payment frequency

You can make mortgage payments monthly or biweekly, for example. Over 25 years of payments you can find you can save a few thousand dollars of interest by making your payments more frequently. However, unless you are tracking your spending carefully, you are probably safer to match your mortgage payment frequency to how often your paycheques are deposited to your bank account.