First Mortgage Advice

[John Delacruz]

Hi, 

I am planning to buy a home. As I don’t have enough savings for that, I have no option other than a mortgage finance. I don’t have any previous experience with mortgages. So, I asked my friends for their suggestions. Most of them asked me to depend on a fixed mortgage finance while others recommended for a variable mortgage. Now, I am totally confused about choosing one.

I searched online to get more details about the same and came to know about a Home mortgage in Toronto. But still, I am not able to take a decision as my credit rating is not too good . And I want to know more about the percentage of down payment also. If anyone has experience with mortgages, please help me to choose a secured mortgage. Thank you.

[Roy N.]

@John Delacruz

No offence to @Joshua Hollandsworth, but you can ignore his mortgage advice as it is not applicable in your situation.

In Canada, you may qualify for a CMHC high-ratio mortgage as a first time homeowner which would enable you to make a downpayment of only 5%.

To decide between a fixed-rate or closed {aka fixed-term) variable-rate mortgage on a personal residence, it comes down to what are your objectives and your ability to deal with financial change.   You can secure either type of financing in a 3-year or 5-year term.  You can secure fixed-rate financing on terms up to ten years - though you would be ill advised to beyond a 5-yr term.

Advantages of fixed-rate:

• payment stays the same throughout the term of the mortgage

Disadvantages of fixed rate:

• higer interest rate
• lower pre-payment options
• larger (interest rate differential) penalty if financing is retired early (i.e. you sell the house)

Advantages of variable-rate:

• lower interest rate (generally)
• higher pre-payment and payment increase allowances;
• penalty of 3-months interest if financing is retired / pre-payed early
• most offerings provide for conversion to a fixed rate product (if rates were to start climbing significantly)
• some products provide a cap on interest rate increase during the term of the mortgage

Disadvantages of variable rate:

• interest rate, and mortgage payment, may change during term of mortgage.

Regardless of whether you opt for fixed or variable rate, and the terms of either, the lender has to qualify you at the BoC posted 5-year fixed-rate (4.6%) with a 25yr amortization if your mortgage is going to be insured (i.e. <20% downpayment).

My preference is to use a variable rate mortgage, but set my payment amount as if it were a fixed-rate mortgage - essentially I hedge the interest rate rather than paying the bank to do it.  This way, if rates rise, I can absorb it out of my increased payment, but in the interim, I'm paying down principal at a faster rate.   If you search the forums, you will find a couple of posts where I ramble on at length about this simple approach.

If you cannot handle a change in your mortgage payment - either fiscally or emotionally - during the term of your mortgage, than you should probable go fixed-rate.

Regardless of whether you go fixed or variable rate, you should opt for accelerated bi-weekly payments rather than monthly, semi-monthly or simple bi-weekly.  This alone will trim 5+ years off your amortization .

Combine accelerated payments with a variable-rate mortgage and increased payment size and you can conceivable cut your mortgage amortization in half during your first term (though in the GTA, this could make you very house poor} saving yourself tens of thousands in interest.    In Canada, mortgage interest on your primary residence is not deductible from your income - so you are making those mortgage payments entirely with after-tax dollars - which gives great motivation to pay down the mortgage on your residence as quickly as possible.

Using the approach above with a variable rate mortgage, payment size set as if the mortgage were fixed-rate, and accelerated bi-weely payments, I retired the mortgage on my first residence in eight years (and interest rates were in the double digits when the mortgage was first placed).