Mortgage Tips
Mortgage payments made with After Tax Cash
More Canadians are becoming aware that, since mortgage interest is not tax-deductible in Canada you are making mortgage payments of both principal and
interest with money that you've already paid tax on — "after tax dollars". This makes it even more important to eliminate the drainage of disposable
income as soon as possible!
Prepayments give great Return on Investment
If you pay an average of 6.5% in mortgage interest, for each $1,000 by which you reduce your mortgage principal, you will save $65 in after tax cash
every year. If you are paying taxes at a marginal rate of 40%, you have to earn $108.33 each year to pay the interest on every $1,000 of principal
outstanding...a heavy burden, but also a tremendous implied benefit to reducing this balance. In fact, the example shows that the "return on investment"
for making prepayments on your mortgage is 10.833% before tax and 6.5% after tax — far better than most fixed return investments (bonds, GIC's
etc.).
Increase your payment annually to the maximum.
The upside is that most lenders will allow you to reduce it again to the previous level if it turns out to be too great a burden or your circumstances
change.
Utilize your RRSP-driven tax rebate as a mortgage prepayment method
Even if you can only prepay annually, make sure these funds are set aside for that purpose. Many Canadians will borrow (at prime) to buy an RRSP to
ensure the maximum rebate. When applied to the mortgage principal, this refund is a "gift that keeps on giving". Combining the refund with the
tax-free interest earned on the RRSP over the subsequent years will quickly outpace the short-term interest costs of the RRSP loan.
Increase the frequency of your payments
Make accelerated bi-weekly payments to get a "free" principal reduction equivalent to one full mortgage payment every year painlessly. Unless you are
paid weekly it makes little sense to make weekly payments. All you'd be doing is making a smaller payment, and deferring the difference for a
week.
Make use of double-up privileges wherever possible
Tell yourself that you will "skip-a-payment" whenever necessary... then skip only when you absolutely must.
Round your payments up
By adding even a nominal amount of say, $10 per payment, the amount of interest you are saving will be unbelievable, and the extra money relatively
painless to part with.
Pay a lump sum whenever possible
By decreasing the principal of the mortgage, your payments will not be allocated as much to interest in the future, thereby accelerating your freedom
to mortgage-free life.
Keep payments the same when mortgage rates have fallen
If the payment amount has not been a problem so far, then keep it the same thus paying down the principal faster.
Raise payments in line with increased income on an after-tax basis
If your income increases, don't keep your mortgage payments the same. Although the disposable income may be fun to spend on unnecessary luxuries in
the short-term, the long-term benefits of being mortgage free faster and saving those interest payments will far outweigh the short-term curtailing
just pretend that your income did not increase and maintain our usual lifestyle.
Additional tips
Get pre-approved for the maximum mortgage you can. Start with your own bank and then get 2 other quotes. Compare not only interest rates but closing
costs and any 3rd party fees.
Make sure your mortgage is portable. If you get transferred or decide to change neighborhoods, most banks allow you to move your mortgage to a new
property without penalty.
Always make your loan and other debt payments on time. Every delinquent item in a credit record reduces your ability to get the best (cheapest) loans.
Lenders care about only one thing...the repayment of debt on time.
If a loan payment has to be late, the hierarchy of loans to be late on are: credit cards, installment loans and mortgages. Always pay your mortgage
first.
Your mortgage loan rate of interest is generally less than any other type of loan. If you have significant debt outside your mortgage, get your bank
to increase the mortgage at your renewal date and pay off the higher interest rate loans.
Take advantage of any bank offering that will reduce your debt quickly. For example, given the choice between one payment per month (monthly) or
half of the payment every other week (bi-weekly), choose the bi-weekly payments. You will end up making the equivalent of 13 full payments per year
if you are paying bi-weekly as opposed to 12 with monthly repayments. But make sure you check that each bi-weekly payment will go towards reducing
your principal and make sure there are no service fees. Note also that bi-weekly is not the same as bi-monthly. Bi-weekly results in 13 full payments
per year. Bi-monthly results in only 12.
Do I Choose A Closed or Open Mortgage
Under a "Closed Mortgage" you will have to stay with the committed interest rate for the duration of the term. Therefore consider a "Closed Mortgage":
- If you are ready to stick with the agreed interest rate for the duration of the term
- If you are of the opinion that the interest rate you are committing to will be the best over the duration of the term
- If you do not have any plan to sell the property before the maturity of the term
- If you are of the opinion that interest rate will not go down significantly during the term of the mortgage
Under an "Open Mortgage" you can repay fully or partially, or convert to a "Closed Mortgage" without penalty. Therefore consider an "Open Mortgage":
- If you are not willing to stick with the agreed interest rate for the duration of the term
- If you are of the opinion that interest rate will likely go down significantly in the short term. You would like to be able to convert to a lower interest rate when interest rate really goes down
- If you believe that there is a strong possibility that you may sell the property in the short term and repay the mortgage
So it is important to discuss both types of mortgages with the assistance of your lender and then make a final choice.
Choosing The Term On An Open Mortgage
If you have made up your mind to go for an "Open Mortgage", you still have to choose the term of the mortgage which is usually either "six month term" or "twelve month term". Interest rate on 6-month term is slightly higher than the interest on a 12-month term. At the end of 6 month or 12 month as applicable, you will have to decide if:
- You want to continue with Open Mortgage at then prevailing interest rate
- You want to repay the loan in full or in part
- Or convert to a Closed Mortgage at prevailing interest rate
Choosing The Term On A Closed Mortgage
If you have made up your mind to go for a "Closed Mortgage", you still have to choose the term of the mortgage which are between 1 year to 10 year term. You should know that interest rate gets higher as you choose a longer term. How long should you go for the term will basically depend on your prediction of interest rate movement. If you believe interest rate will drop significantly, you would probably choose a shorter term. If you believe interest rate will go up significantly, you would probably choose a longer term. Again you should consider if there is a possibility that you may want to sell the property and pay off the mortgage way before reaching maturity.
There are two types of Variable Rate Mortgages
- Open 5 year term. The interest rate is higher than the 5 year closed term but you have the flexibility to pay off the mortgage any time without penalty
- Closed 5 year term. The interest rate is lower but there is a prepayment penalty if you pay off the mortgage before maturity
Use Your RRSP Money As Downpayment The hardest part in purchasing a property is to find the "Downpayment". If you have some RRSP (Registered Retirement Savings Plan) money in the bank, you may borrow from your own RRSP and use the money as a downpayment, without increasing your tax liability. For more information, refer to the Canadian Government's Home Buyer's Plan.
Get A gift From Parents For Downpayment Lenders will accept that your parents give you the downpayment as a gift. All you need is a letter from your parents confirming that the amount is a gift from them. Lenders will not accept if it is a loan from your parent.
Choosing A Cash Back Mortgage Can Help With Downpayment Cash back mortgage is a mortgage where the lender will give you some cash back at time of closing. You can use the cash back to pay for furniture, legal expense, even as part downpayment. You can receive back 4%, 5% or 7% of the mortgage amount but the catch is that you have to choose a fixed mortgage and the term must be at least 4 years. Also the interest rate will unfortunately be higher than standard mortgage rate.
Obtain A Pre-Approved Mortgage You do not need to wait until you have made an offer to purchase a home before you go to the Bank or other lenders to apply for a mortgage. You can go to the Bank or other lenders first and get a pre-approval. In this way you know for sure that once you find a home, your mortgage is already approved. Also pre-approved mortgage is particularly useful when interest rate is rising because lenders commit and guarantee upfront an interest rate, usually good for 60 days. The good part is that if you cannot find a home within the 60 day period you have no obligation whatsoever.
Take Advantage Of High Ratio Mortgage The hardest part in purchasing a property is to find the downpayment. The sad part is that by the time you have the downpayment, the property price may have gone up so much that you cannot afford the monthly payment anymore. High Ratio Mortgage allows you to put as low as 0% down instead of 20% down for conventional mortgage. If you have a good credit rating, a good steady job, a good salary and can meet the Gross Debt Service Ratio and Total Debt Service Ratio of the lender, you may qualify for high ratio mortgage.
Rent A Room To Increase Income If your income is not enough to qualify you for a mortgage, some lenders may accept that you rent part of the house to increase your income level to meet the GDSR and TDSR ratios.
Save Interest With Debt Consolidation If you have debts all over the place: credit card debt, personal line of credit, overdraft, car loan, consumer loan, department store loan that charges very high interest rate, you may consider consolidating all the debts into one single loan that offer much lower interest rate. If you have a home that still have some equity, you may consider refinancing your mortgage for a larger amount and for a longer amortization period and pay off all your other debts. Your can save much on interest expense.
