Tuesday, June 18, 2013

Buying a house without taking on more than you can afford...

The housing market has been buzzing in Edmonton over the last month of so. I've been so busy trying to keep my head above water I haven't had time to write a blog entry. But, I wanted to take a moment to talk about the current interest rate environment and how mortgage holders can use this time to their advantage.

Five year fixed mortgage rates that hover around 3% are extremely low when you look at interest rates over the last 25 years. It's basically unheard of.

In one sense, it's wonderful that borrowers can qualify for a mortgage at these historically low rates, allowing them to qualify for a higher mortgage than if rates were, say 5%. What worries me a little is what will happen to my clients in 5 years when their mortgage renews and interest rates are 5%, as an example?  

Let's crunch some numbers! Let's say you're a typical urban couple in Edmonton starting out. You've finished school and worked hard to put your down payment together. You and your new spouse have purchased a house today for $400,000 and have a 5% down payment:

Purchase price
$400,000
Less: down payment
$20,000
= Mortgage amount
$380,000
Add: default insurance
(2.75% of mortgage)
 
$10,450
Total Mortgage
$390,450
Monthly payment at 3.00% over a 25 year amortization
 
$1,847.49

Great! So you've bought your house and been approved for the financing. Your monthly payment is $1,847.49 and you're comfortable with that. But, have you taken a moment to consider what happens in five years when your mortgage is up for renewal? You'll be offered whatever rates are on the table at that time. What if rates have risen substantially during the last 60 months? I know no one really wants to think about that. Five years seems so far away and surely everything will be just as economically wonderful in Alberta as it is now. Right?
Let's take a moment to consider how your mortgage would stack up if rates have risen to 5%. If you've made monthly payments for the first five years of your mortgage, using the example above, you'll owe $333,735.60 on maturity. You've paid $56,714.40 down on your mortgage. Your mortgage lender has offered you a renewal at 5% (the best going rate at the time). If your new mortgage rate is 5% what does this do to your monthly payment?

$333,735.60 at 5% over a 20 year amortization = $2,193.06/month.

That's right. Even though you have a lower mortgage balance, because interest rates have risen, your monthly payment has now gone up by $345.57.

Reading this you might think I'm a bit out to lunch. Of course you'll be making more money in 5 years, and of course your house will be worth more money than what you paid for it and surely you could sell it if things went bad. Is this true? Not necessarily so. Even if your income has increased, your expenses likely will have increased as well. Maybe you've decided to start a family ($$$...diapers aren't cheap!), perhaps you've bought a swanky new vehicle to drive your new family around. SUV? Minivan? Again, not cheap and I'm guessing you'll have a vehicle payment between $600-$800 a month). And, if you've started a family, one of you has probably taken some time off work to care for your children, creating a bit of a financial strain.

As for the value of your family home? Anyone that purchased a property after 2008 will surely tell you that house values don't always go up in the short term. Other things can happen too...illness, job loss? I'm not trying to be a downer but life does have a way of throwing some curve balls as the years go by.
My point is, things don't always go the way you've planned and, as consumers, the onus is on you to keep your spending in check and make sure you can handle the bumps life will surely offer up.

My advice is this: If you are thinking of purchasing a home and taking advantage of these rock bottom interest rates, do so. It's a great time to buy! But, I urge you, make sure you can comfortably afford the mortgage payment at 5% instead of 3%.
Would you be able to cope if you're mortgage payment increased by almost $350 a month? If the answer is no, I would caution you to reconsider home ownership or, perhaps, lower the purchase price of your new home to accommodate a higher interest rate.  

If you are jumping into the home ownership game, I urge you to take advantage of your mortgage lender's pre-payment privileges and pay your mortgage as if you are borrowing the money at 5%, instead of 3%. Not only will you know you can weather the storm should rates be higher in 5 years, you'll make a huge dent in your mortgage balance (at the end of your 5 year term you'll owe $311,425.28 instead of $333,735.60).

I read a stat today that said only 18% of Canadians pay extra on their mortgage every year. I find that pretty disappointing considering that this is an amazing opportunity to use these low rates to create more wealth for your family.
If you would like some information or ideas on how to pay your mortgage off faster or take advantage of the low rates being offered feel free to contact me anytime!

Natalie Wellings, Edmonton Mortgage Broker

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