Increase your equity while protecting your debt

A mortgage is usually the biggest financial commitment — and greatest risk — most people are likely to assume in their lifetimes.

Buying a home is a leveraged investment, not unlike buying stocks on margin. With just 10 per cent down, a homeowner takes on debt equal to 90 per cent of the acquisition cost of the property. The immediate increase in net worth is negligible and equity grows at a glacial pace as most of the mortgage payments in the early years cover interest charges. Unlike stocks, housing is not a publicly traded asset so there is no reliable way to track daily housing prices.

However, they can be as volatile as a penny stock, as millions of Americans recently discovered. And over the long term, housing performs little better than the rate of inflation. Seen in this light, both equity and debt need attention.

Homeowners know regular maintenance is required to keep a home shipshape. Outside the irrational Vancouver real estate market, a home that is in good repair will be worth more than one that isn’t. But keeping the mortgage in good standing is equally important, and that means never, ever missing a payment, even when a financial institution offers a deferral, as some do around Christmas.

If a homeowner has chosen a mortgage wisely, the lender will allow weekly or biweekly payments, rather than the more common monthly schedule, which will pay off the mortgage more quickly. It may also allow an increase in those payments as cash flow permits, directing more of the payment to principal. And there will be anniversary payment opportunities, giving the homeowner the option of making a lumpsum payment each year to be applied directly to principal.

Unless the property was purchased solely for investment purposes — in which case other considerations come into play — borrowers should take advantage of these terms whenever possible.

Mortgage holders need to keep an eye on interest rates and challenge the lender, if necessary, to meet or beat the competition.

When Bank of Montreal cut one of its five- year rates to 2.99 per cent this year, other financial institutions, fearing mass defection, responded by lowering rates on some of their mortgage products.

Although homeowners often fail to recognize the risk implicit in their mortgage debt, financial institutions do.

They insist highly leveraged borrowers, those who put down less than 20 per cent of the purchase price to buy mortgage loan insurance, which guarantees the debt against default. A buyer putting down 10 per cent on a $ 550,000 property will pay a mortgage insurance premium of $ 2,475 ( assuming a premium of 0.5 per cent) which, in most cases, will be added to the mortgage loan.

Some financial institutions urge borrowers to take out mortgage life insurance even in situations where mortgage loan insurance is not mandatory to ensure the debt is paid in the event of the borrower’s death.

Financial advisers, however, tend to favour basic term life insurance over mortgage life insurance, pointing out the premium on mortgage life insurance doesn’t change even as the amount to be repaid declines as the mortgage is paid down. Term life insurance, on the other hand, pays out the original face value of the policy.