Today, I’d like to share with you my understanding of the mortgage market and some specific tips on how to save money.
Why do we need a mortgage
Buying a house is probably one of the largest, if not THE largest, purchase, that you will make in your life. Unlike a burrito wrap or a jacket that you can pay with your own cash, a house most often carries a value that is substantially more than what we have in our bank accounts. Because most people (myself included) do not have enough cash on hand by the time that we purchase the house, we resort to the financial vehicle called mortgages.
Deep dive into the mortgage market
A mortgage is basically a loan that you borrow from your lender. You can use the money right away to get the house, but you will have to pay back the debt gradually by making regular payments, and some more to cover interest. Banks and mortgage brokers charge interest because they have to provide the money to you now. As we know, because of inflation, $100,000 can buy more stuff 30 years ago that it can now. They also run the risk of your defaulting and of course, they want to make a profit by providing you money that you don’t have at the moment. You get some benefits in the mean time as well, because you get to enjoy a house without having to pay the full market value at once, which could be a serious detriment to your personal cash flow.
Example: You will have to pay in total $200,000 interest on a 30-year $400,000 mortgage with an interest of 3%.
Of course, the interest can rack up over the long time. For example, if you have a 30-year $400,000 mortgage with an interest of 3% over its lifetime, by the time you finish paying it all off, not only will you return the full $400,000 to the mortgage broker, you will also have paid them more than $200,000 on interest.
A key thing to note is that 3%, while it may seem high in today’s COVID-19 environment when the central banks are slashing interest rates to try to boost the economy, is actually quite low when you look at the last fifty years of mortgage history. The graph below shows you the historical posted 5-year mortgage rates from ratehub.ca:
Of course, given the fact that mortgages are heavily discounted in reality, I think below is a more realistic view of the mortgage rates a regular consumer should be able to get:
As you can see, it is only in recent years that mortgage interest has been hovering around 3%. Should we expect it to last? Nobody knows (especially in today’s COVID-19 environment), but I think it’s better to be on the cautious side and assume that it is possible that the interest rate will go up in the future.
Since mortgage is such a huge financial burden but also a critical piece of debt instrument that many of us will carry, it is worth giving it some considerable thoughts. Below is a list of tips I have for you when you are considering taking on a mortgage for a home. Please take advantage of them to help yourself save money.
Money-saving mortgage tips
1. Set a budget and stick with it.
- It is important to review your full financial picture to understand how much you can afford before heading into the housing market, and stick to your budget.
- Many money experts recommend that you do not spend more than 30% of your pre-tax income on your mortgage. There are so many other things you should take care of in life, such as your own well-being, your children’s education, helping others, and retirement. You do not want to be a slave of your house and eating only mac and cheese.
Use a mortgage calculator to find out about how much you can afford
Nowadays, there are many resources online that help you determine how much you can afford. Mortgagecalculators.info provides such a calculator, called Mortgage Affordability Calculator. By simply entering your current monthly income and existing monthly debt payments, such as your credit card debt, you can easily find out how big of a mortgage you can afford.
Here is a screenshot of the calculator:
As you can see, there are some default settings already included in the calculator. They form a good starting point if you are at the beginning of your research.
Once you hit “Calculate”, you will see the following results page. You can quickly see information such as the maximum monthly mortgage payment and your maximum loan amount.
Of course, once you have a good baseline thanks to these default settings, you can adjust these settings to run different scenarios. For example, you may want to shorten your term of the loan from 30 years to 25 years because you want to pay off your mortgage earlier, or you may expect your income to go up because you recently accepted a promotion.
2. Choose a reputable mortgage provider, but do not be afraid to shop around (actually, please take some time to).
- I think most people will prefer reputable mortgage providers because mortgage is such a large sum of money and reliability may be an important factor of consideration, even though these institutions may charge a premium in terms of higher interest rates.
- However, it shouldn’t prevent you from shopping around and speaking to a few providers before making a final decisions. While most people may find it the easiest to just go to the bank that you do your everyday banking with, the bank may not give you the best deal. Even a 0.05% difference in interest rate could have a huge impact on the overall interest you will have to pay, so it is worthwhile to do a bit more exploration. Shopping around also helps you gauge the market, so you can make an informed decision, which will minimize the chance of buyer’s remorse.
3. Check your company’s perk book.
- Your company may actually have partnerships with specific mortgage providers that offer you a great discount. This is a win-win-win situation for all parties involved. You, the employee, get to have an exclusive discount. Your company, the employer, get to have some word-of-mouth exposure through the clients of the mortgage broker. The mortgage broker gets to attract a large clientele (just imagine how many people in your company are potentially interested in buying a house!).
- The mortgage brokers who are able to form a partnership with your company are usually vetted first by your human resources department, so you get the added benefit of knowing that they are reliable.
- Even if your company doesn’t have such a benefit, it might actually be beneficial to pitch the idea to your human resources department. Employee retention is a key metric in any HR department’s success, so they have vested interest in making sure that employees are satisfied with the work environment and the benefits provided. Of course, you need to plan ahead and make sure you propose the idea at least a few years before you actually need the mortgage, because it could take quite some time for it to happen.
4. Negotiate even if you are in the middle of a mortgage term. Your lender may surprise you.
- The mortgage term is specified in the mortgage agreement. The most popular ones are 3-year or 5-year terms. This means that the interest and the type of mortgage (fixed vs. variable) is fixed over that period of time.
- That does not mean that you should not negotiate if you find a better deal offered by the same broker (e.g., if the economic condition changes such as COVID-19 right now) or by a different one. I have to warn you that it is very unlikely for your lender to just change the terms to your advantage, and they have all the rights not to do so since it is a signed contract, but you may be surprised. At the end of the day, there’s no harm trying, right?
- What will more likely to happen is that the bank will allow you to break the mortgage agreement, but you will have to pay a penalty. Exactly how much penalty you will have to pay depends on the lender’s internal policy, but the general idea is that they want to recoup some of the interest they could otherwise earn if you fulfilled the full agreement.
- This will require some diligent calculation on your part to understand whether it is worth it to pay the penalty now and enjoy a more favourable interest rate over the next few years before your next renewal comes up. Sometimes it is, sometimes it is better to just leave it the way it is.
What are your thoughts? Are there any other mortgage tips that I haven’t touched on that you think may be beneficial? Please share in the comments below!
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