With mortgage rates low and lenders tripping over each other to entice home buyers, borrowing has rarely looked so appealing.
You can get a traditional mortgage or a line of credit, you can prepay the loan, then turn around and write yourself a cheque, raise your payment or lower it, even skip a payment if you need to.
Interest rates are still the main consideration for most mortgage shoppers, says Nicole Wells, director of consumer lending at ING Direct in Toronto. But the lowest rate may come with lurking restrictions that only reveal themselves later when you try to change terms or switch lenders.
“When you’re looking at a mortgage, make sure you understand what you’re getting into,” Ms. Wells says. Choose financing that suits your particular needs, income and stage of life.
Flexibility is key. Indeed, in a recent survey for TD Canada Trust, respondents said the flexibility to pay off their loan faster and defer or reduce payments in an emergency was top of mind.
But flexibility can involve tradeoffs as well, says Nelly Van Berlo, president and owner of Dominion Lending Centres the Mortgage Source in Ottawa. Lines of credit, for example, are ideal for people who want to pay off their loans as quickly as possible. But costly penalties can make it expensive to switch lenders in the future, she notes.
The following are five ways to put some flexibility in your mortgage loan:
1. Size. If you have the income and a good credit rating, you can borrow as much as 95 per cent of your home’s value, but should you? Probably not. By waiting until you have saved enough for at least a 20-per-cent down payment, you will save on mortgage insurance fees, which can be substantial. The fee for mortgage insurance with a 5-per-cent down payment is 2.75 per cent of the loan’s value, or $2,750 for every $100,000 borrowed – a high price to pay for insurance that protects the lender in case you don’t pay.
Making a good-sized down payment also leaves you room to borrow using a home equity line of credit if an emergency arises or if you decide to renovate. And a big down payment gives you an equity buffer if house prices fall and you have to sell for some reason.
2. Traditional or collateral. Traditional mortgages are secured directly by the property, whereas collateral loans such as lines of credit are promissory notes with the property pledged as collateral. If you want the freedom to switch lenders at some point, traditional mortgages are more easily transferred, Ms. Van Berlo says.
While lines of credit offer borrowers great flexibility, the loan would have to be registered by the new lender if you decide to switch in the future, resulting in large legal fees, she says. As well, lenders charge monthly interest on collateral loans, while interest on traditional mortgages is calculated semi-annually (the more frequently interest is calculated, the more interest you pay).
If you have trouble saving, the fixed payments of a traditional mortgage may be more suitable because unless you are really disciplined, the temptation to keep drawing on your line of credit may prove too great.
3. Fixed or floating. Choosing fixed or floating interest rates is likely the most difficult decision for new and seasoned borrowers alike because interest rates are unpredictable and are determined by currents in global financial markets. Yet the rate you pay is critical because it will determine how much of a loan you can afford.
The trouble is, interest rates change over time, so you could take out a $200,000 mortgage loan now at 3.5 per cent and find yourself paying twice that amount five years from now. Alternatively, if you lock in for five or seven years now, you will be paying higher rates from the get-go.
The most flexible type of loan is one that gives you the benefit of low variable rates now but leaves you free to scramble for the safety of a fixed term without penalty at the first sign rates are on the rise.
4. Amortization. This is the time over which the loan is spread; the shorter the better, in terms of interest. Over the entire amortization period, the rate of interest you pay will vary. If you are a first-time home buyer, spreading your loan over 30 years may seem like a good idea because it lowers your monthly payments initially. But the longer you owe the money, the more interest you will pay. On a $100,000 mortgage loan at 4 per cent amortized over 30 years, you will pay $71,187 in interest. The same loan amortized over 20 years will cost $45,019 in total interest, a saving of $26,168.
“But I can make extra payments and pay off the loan more quickly,” you protest. The question is, will you?
5. Fees, restrictions and charges. Suppose you have chosen a variable rate mortgage with a lender you feel comfortable with. The lender says you can switch to a fixed-term rate whenever you choose. Before you sign, check to see if there is a difference between the lender’s posted rate and their “special” or discounted rate. The spread can be up to a full percentage point.
“When considering a convertible product, the client truly has to get in writing what they will get for the conversion rate,” Ms. Van Berlo says. “Will it be the posted rate or the special discount rate?”
In the end, “the starting point is your personal budget,” says Farhaneh Haque, regional sales manager at TD Canada Trust in Toronto. “Don’t overextend yourself. Leave yourself breathing room,” she adds, “and really understand the features and options.”
(Article Source: The Globe and Mail, May. 10, 2011)
