“Catch a man a fish, and you can sell it to him. Teach a man to fish, and you ruin a wonderful business opportunity.” – Karl Marx
Recently, I ran a series of workshops for a client and one of the topics I was asked to talk about was buying a home. I included a “5 common questions about mortgages” section that was really well received, so I thought I would use it as the inspiration for this week’s post.
Initially, I was surprised by how useful people found the information. However, when I thought about it, I realized that, just like the financial services industry, the mortgage industry does a great job of feeding us information rather than encouraging us to inform ourselves. Unfortunately, there’s no guarantee when you’re handed information that it’s objective or that you’ve been given the full picture. One of the challenges in dealing with any industry where the majority of representatives are working on a commission basis, is that you’re never quite sure whether the information you’re getting is truly impartial. If someone’s ability to eat depends in part on whether or not you buy what they’re selling, then it’s especially important to invest a little time into researching it so that you can make sure you ask all the necessary questions. This way you can be more certain that the deal benefits you just as much as it benefits the person doing the selling.
As a starting point for your own research, I’ll share the five most common questions about mortgages that I get and my usual responses:
1. Should you use a mortgage Broker or Bank?
With so many mortgage lenders out there and so many options online as well as with “bricks and mortar” institutions it’s not surprising that people aren’t sure where to turn. My suggestion is that, even if you’d rather deal with your bank, start with a broker because they can give you a much better idea of what rates and options are available in the marketplace and they can often get a better rate from your bank than you can. Once you have an idea of what’s on offer, you not only have a better idea of what product is the best fit for you but you’re in a much stronger position to negotiate with lenders.
It’s no different than walking into a car dealership to buy a car. If you’ve done your research and know what else is out there and what other dealers are offering you’re in a much better position to evaluate whether what the salesperson is telling you is correct and whether the deal they’re offering you is a good one. If you walk in, having done no research at all, then you have to take the salesperson at face value and trust that what they’re offering you, is truly the best deal for you and not simply the best deal for them.
On a side note, when it comes to choosing a broker to work with, the best ones are not usually advertising on park benches or on buses. Good brokers tend to get most of their business from referrals so, rather than relying on Google, ask friends and family who they deal with and who they’d recommend.
2. Fixed Rate or Variable?
Studies show that people with variable rate mortgages tend to pay off their mortgages faster and pay less interest over the term of their mortgage than those who opt for the fixed rate. A 2001 study by a York University professor found that, from 1950-2000, a variable rate mortgage would have been better for Canadian homeowners 90% of the time and would have saved the average homeowner about $20,000 in interest over the full mortgage term. However, often people are intimidated by the idea of a variable rate mortgage because the payments have the ability to go up as well as go down and they prefer the stability of a fixed mortgage payment.
One strategy that lets you take advantage of the lower interest on a variable rate mortgage while keeping the stability of a fixed rate, is to take the variable rate option but set up your payments as if the mortgage was at a fixed rate. For example: Fred and Beth have the choice between a variable mortgage rate of 1.95% and a fixed rate of 2.60%. At the 1.95% rate, the accelerated bi-weekly payment on their $430,000 mortgage will be $905. At the 2.60% fixed rate, it will be $975. Fred and Beth decide to round the numbers a little and so they set up their mortgage payment to be $1,000 bi-weekly. In this way, they have the security of a fixed payment and, if interest rates start to rise, any increase in their payment won't affect their budget, because they’re already paying 10% more than they need to.
The advantage of doing this is that, while interest rates are low, Fred and Beth will be paying an extra $95 bi-weekly off the principal of their mortgage. That might not sound like a lot, but it could shorten the time it takes them to pay off their mortgage by three years. At any point, if interest rates start to skyrocket and they want the security of a fixed rate, they can switch to a fixed rate mortgage but at $1,000 bi-weekly, their payment is the equivalent of having a fixed rate of 2.85% so they have a decent buffer zone.
Related article: Which is better – variable or fixed mortgages?
As with many things in life, when it comes to mortgages and financing a home purchase, everyone’s situation is slightly different and what works for one person might not work for another. However, when you consider that buying a house is the most significant financial commitment most of us will ever make, it’s really important to do a little research and to spend some time talking to people who’ve done things “right” as well as those who’ve made “mistakes” in order to learn from their experiences. Too many people get caught up in the excitement of house-hunting and creating a home and don’t take the time to consider what they’re signing up for when they’re applying for financing. Once the deal is in place, it can be impossible (or incredibly expensive) to make changes so it’s worth taking the time to make sure that the lender you’re giving your business to, is actually offering the best product for your needs at the best rate.
3. Mortgage Insurance or Life Insurance?
I feel so strongly about this particular question that I’ve already devoted an entire post to answering it! In a nutshell, there are three key issues with mortgage insurance which make life insurance a far better choice for protecting your mortgage debt in the event that you pass away.
Firstly, a life insurance contract is underwritten before it’s issued. This means that the insurer has taken your application, ordered blood work and requested your doctor’s records in order to evaluate whether or not they’re willing to insure you and at what rate. Once the contract is issued, if you pass away, then the insurer is guaranteeing to pay the value of the life insurance policy to your named beneficiary(ies). With mortgage insurance, the underwriting happens when a claim is made not when the policy is issued. This means that, if there’s anything in your medical history (whether you knew about it or not) that doesn’t jive with the answers you gave on your application form, the insurance company doesn’t have to pay off the mortgage, it just has to refund the value of the premiums that have been paid. I’m not a big fan of paying for something that’s not guaranteed to pay out which is the main reason I always recommend a stand-alone life insurance policy over the mortgage insurance that most lenders offer.
The second reason that life insurance is a better option is that, if something were to happen to you, it pays the person (or people) that you named as your beneficiary whereas mortgage insurance pays the bank. This is important, because in many circumstances, living in a mortgage-free home isn't necessarily the best option for the survivor. For example, if a couple have young children and one passes away, then the surviving partner might opt to use the insurance money to offset the drop in household income rather than pay off the mortgage. If there are other people with a financial interest in the house (children, siblings etc.) then perhaps being able to settle those interests without having to sell the house might be useful. With life insurance the beneficiary can choose what the money is used for, but with mortgage insurance the payout goes automatically to the bank.
The third advantage of life insurance over mortgage insurance is that the value of the policy stays the same throughout the insurance term. I have a 20 year, $500,000 term life insurance policy to cover our mortgage and the premiums are guaranteed to remain the same throughout the 20 years term. If I die this year, my husband gets $500,000. If I die 19 years from now, he gets $500,000. With mortgage insurance, even though the premiums you pay remain the same, as your mortgage balance gets smaller, the value of the policy decreases. For example, if we had mortgage insurance and I died this year, the $470,000 mortgage would be paid off but if I died 19 years from now and our mortgage balance was only $50,000 then only the $50,000 balance would be paid off even though the premiums would be the same.
Related article: Do some homework before you buy mortgage insurance
When you consider that, in addition to being guaranteed to pay the full face value to whoever you choose, life insurance premiums tend to be similar, if not cheaper, than mortgage insurance premiums, it’s easy to see why life insurance is a better option to protect mortgage debt.
4. Should You Pay Your Own Property Taxes?
Most mortgage lenders offer you the option to have your property taxes included in your mortgage payment. Sometimes, this is a condition of the mortgage and you don’t have the ability to opt out. However, if you do have the option to pay your property taxes yourself, it will cost you less than if the bank pays them for you. Not surprisingly the bank charges a fee for holding back money from each mortgage payment and remitting it to the municipality on your behalf. Paying the taxes yourself lets you avoid this fee. It also lets you earn interest from holding the money in your own savings account for a few months rather than letting the bank make money from it in theirs!
5. Should You Pay Off Your Mortgage Early?
Just because the term of your mortgage is 25 years doesn’t mean you should take 25 years to pay it off. The lenders like us to take 25 years to pay it off because then they make the highest amount in interest from the loan. However, a low rate of interest paid over 20-30 years still adds up to a significant amount of money which is why many people like to pay off their mortgages as soon as they can. While there are lots of arguments to be made for and against paying off your mortgage early, my personal philosophy is that, if you have the ability to get it paid off early then go for it. I see a significant difference between people heading into their 50’s and 60’s with their mortgages paid off compared to people who are still paying off their homes. For most people, their mortgage is one of their biggest monthly expenses, so once that commitment is paid, it frees up a significant amount of money for saving or other financial goals. It also reduces the amount of income that they’re likely to need in retirement which helps their retirement savings last longer and allows for a better quality of life.
Related article: Why you should pay your mortgage down sooner
Adding a relatively small amount of money to a regular mortgage payment can have a surprising impact when it comes to getting the mortgage paid off faster, especially if you do it early in the life of the mortgage. Most mortgage lenders will allow you to pay 10-20% of the original mortgage amount off the principal each year without penalty (check your lending agreement for details). A 25-year mortgage can be shortened to 23 years by making the equivalent of one extra payment per year (or opting for the ‘accelerated bi-weekly’ mortgage payment option). Adding 10% extra to your mortgage payment (paying $1000 instead of $905 for example) can knock another 3 years off the length of time it takes to become mortgage free. If you want to take a more aggressive approach, then you could follow in the steps of clients of mine who are planning to double up their mortgage payment once some major loans are paid off later this year. Depending on interest rates, their 25-year mortgage should be paid off in just under 9 years, leaving them mortgage-free at 51 with $4,000 per month in extra cashflow. Not bad for a couple who, just 4 years ago, were $50,000 in debt and living paycheque to paycheque!
Related article: How to pay off your mortgage faster
While everyone's situation is different, it never hurts to do a little research, ask others for their suggestions/tips and do whatever you can to put yourself in a situation where you're making an informed decision about your mortgage future.
If you have any mortgage tips, strategies or warnings that you'd like to share, I'd love to hear them!