The No. 1 question to ask about your next mortgage is not whether you got the lowest possible interest rate, or how fast you’ll pay it off. Instead, ask yourself this: How much stress will your mortgage cause you in the years ahead? If the lowest rate mortgage fries your nerves, it’s arguably not the best deal.
The long cycle of falling interest rates is done like dinner. Comments made by the Bank of Canada after it recently increased its trendsetting overnight rate for the fifth time since summer 2017 suggest we will see several more rate increases unless the economy tanks.
De-stressing your life as a home owner in this rate environment requires some fresh thinking, such as considering the merits of a 30-year amortization instead of the traditional 25 years.
If you have a down payment of less than 20 per cent, you’re stuck with a maximum 25-year amortization. By putting down 20 per cent or more, you open up the possibility of going to 30 years.
The longer amortization means lower payments at the cost of more interest paid over the life of the mortgage. Minimizing interest costs is really important, but there’s value in having a mortgage that gives you room to breathe. That makes it easier to afford home upkeep, start a family, make your car payments and save for retirement without running a perma-balance on your credit card or line of credit.
Mortgage broker David Larock said about half of his clients who have down payments of 20 per cent or more are using 30-year mortgages these days. A typical example would be working spouses who will go down to a single income in a few years when they start a family.
“They’re willing to pay more on interest for the flexibility of having a lower payment,” Mr. Larock said. “Basically, it’s like cash flow insurance. They know there’s a premium involved, but they’re willing to pay it.”
Consider a $500,000 house bought with the combination of $100,000 down and a five-year, fixed-rate mortgage at 3.5 per cent. The monthly payment is $1,997 for a 25-year amortization and $1,790 for 30 years – that’s a savings of 10 per cent for the 30-year option. Total interest paid is $199,123 for 25 years and $244,595 over 30 years – that’s a 22.8-per-cent increase for using a 30-year amortization.
Mr. Larock said the actual interest costs could be slightly higher because lenders offering 30-year amortizations typically charge a small rate premium over 25-year mortgages, say about 0.25 of a percentage point. But 30-year mortgages are about flexibility and comfort, not cutting interest costs to the bone.
One further cost of the 30-year mortgage is the extra years it takes to pay your debt in full. But with people living and working longer, it may be that these extra years can be absorbed without problems.
Here’s a compromise if you’re gagging on the idea of paying that extra interest: Set up the mortgage with a 30-year amortization, but make extra payments so that you end up paying the amount you would have if you went with 25 years. “When you to go down to one income a couple of years from now, you can cancel the extra payments and get back to the lower minimum payment,” Mr. Larock said.
Similar logic can be applied to the question of whether to go with a variable or fixed rate. Past experience shows variable-rate mortgages have generally offered lower rates and thus less interest cost.
But there’s a psychological side to this argument as well. People who bought a first home since 2008 have no experience with steady interest rate increases – they’re used to rates being a benign force in home affordability. Experienced homeowners may take this change to the rate outlook in stride, but nervous types and rookies will agonize over each move higher in rates if they have a variable-rate mortgage.
Expensive houses and rising rates make people desperate to get out from under their mortgages as soon as possible, which is definitely smart personal finance. But a mortgage has to fit your life. If you make your life fit your mortgage, there will be stress.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, November 8, 2018