Both variable and five-year mortgages are now available for less than 3 per cent. Those low rates won’t last forever, and there’s a simple way to protect yourself against rising rates and save money at the same time.
Finance Minister Jim Flaherty had the right idea last year when he tightened the rules for mortgage insurance by cutting the maximum amortization from 30 years to 25.
Critics argued that because this measure boosted the minimum monthly payment for an insured mortgage, many Canadians who would have bought homes could no longer qualify – and have blamed this change for the subsequent slowdown in real estate markets.
But all Canadians planning to take advantage of today’s low rates to buy a home or renew a mortgage would be wise to follow Flaherty’s lead – and go a step further by opting for an even shorter amortization.
Let’s look at the numbers. According to the Canadian Real Estate Association, the average price of a home sold in Canada in February was $368,895. If we assume a moderate down payment of close to 20 per cent, that would mean a $300,000 mortgage.
A variable-rate mortgage at 3 per cent interest with a 25-year amortization would have monthly payments of $1,423. If instead you aim to pay off the mortgage in 20 years, the monthly payment jumps to $1,663, an increase of $240. (All numbers are generated by RBC Royal Bank’s online mortgage calculator).
Can’t afford it? Look at what happens if you stretch that 3 per cent mortgage over 25 years, and then have to renew at 4.5 per cent. Your new monthly payment becomes $1,667.
In other words, if you shorten the amortization by five years now, you can take comfort in knowing that you will still qualify on renewal even if rates go up by 1.5 percentage points.
You’re also going to save a lot of money over time if rates stay low. The total cost of interest on a 3 per cent mortgage paid off in 25 years is $126,789. If you pay it off in 20 years, the cost drops to $99,310.
Let’s take this to an extreme. What happens if you cut your amortization to just 15 years? Even at 3 per cent, the monthly payment jumps to $2,072.
But if you can afford that, you are safe against rates going as high as 6.75 per cent. That’s when a 25-year mortgage would hit monthly payments of $2,073. And by taking on that payment right away, you could save almost $54,000 in total interest costs if rates stay low.
It’s true that if you lock in a 3 per cent rate for five years, you’ll have a smaller balance when it comes time to renew. But at a 25-year amortization, you’ll pay off less than 15 per cent of the principal in the first five years.
And a lot can happen to interest rates in that time. Even within the past decade, the prime rate (which drives variable-rate mortgages) rose by as much as 1.75 percentage points in less than one year, between August 2005 and May 2006. Term mortgage rates have varied even more.
Last year’s decision to cut the maximum insurable amortization from 30 years to 25 simply protected Canadians against the risk of losing their homes over a single percentage point increase in rates. If you’re buying or renewing this year, save money and reduce your risk by cutting your amortization as much as you can afford.
David Stewart-Patterson is vice-president, public policy at The Conference Board of Canada, and once paid 20.25% for a mortgage.
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