Courage. Optimism. A crystal ball. And the glint of the gambler’s eye. These seem to be the minimum prerequisites to take pen in hand and sign an agreement to purchase a home today.
Only one word describes the present mortgage market: volatile. As interest rates fluctuate in a confused, uncertain atmosphere, lending institutions are reluctant to offer the traditional term mortgages whose rates were readjusted every five years. In fact, lately some companies have been offering mortgages whose interest rates are renewed every six months.
How can a beleaguered family know whether now is the right time to buy a house when even the experts cannot agree? The pessimists among them advise buying now before the rates go up again. Optimists, conversely, suggest waiting a year or so, hoping the rates will ultimately peak and fall. The only consensus among economists these days is: no one has any answers. Until our economy is no longer tied so closely to the United States, our interest rates will correspondingly rise and fall.
Few among us can afford to pay cash for our new home. Therefore, when shopping for that inevitable mortgage, the informed purchaser must become familiar with the variables common to all mortgages. Every mortgage has a dollar value; an interest rate; a term of renewal; an amortization period; and will be
either open or closed. The combinations of these factors determine how much the mortgage will ultimately cost you.
The interest rate, the subject of so much speculation in this-bewildering market, affects your monthly payments, which are calculated over the amortization period of the mortgage and recalculated at the renewal of the term when new interest rates are negotiated.
The term is the period of time in which the present interest rate is fixed. T raditionally, it was readjusted every five years. Today, mortgage companies are reluctant to offer terms even as long as three years. The longer the term, the higher the interest rate.
The amortization period is the overall length of time you would hold the mortgage if it did not have to be renewed: it is used simply as a basis for calculating your monthly payments. In other words, if your payments are calculated on the basis of a 15-year amortization period, they would be very high; usually the amortization period is 20 or 25 years. So, while your monthly payments are considerably less with a 25-year amortization period, you pay a lot more in the long run. Best to get the shortest amortization period your cash flow can handle; more of your money goes to paying off the principal.
Mortgages may be open or closed. An open mortgage may be paid off at any time without notice or penalty. However, one pays a
higher rate of interest for that privilege. A closed mortgage has a lower interest rate than an open mortgage. However, the mortgagee is locked into the terms of the mortgage and, if interest rates fall, in some cases it becomes impossible to get out of the mortgage and to refinance at the new, lower rate. In other situations, a substantial penalty - from 3 to 9 monthly payments - may be imposed to discharge the mortgage. This is at the discretion of the lender.
Since the experts in the field are reluctant to predict trends for the next few disruptive years, how does the prospective homebuyer secure a mortgage that will give him the most flexibility in such a volatile market? Home Life spoke with Michael Stephenson of Executive Compensation Consultants Ltd., Toronto, who suggests the following steps will protect you when buying in uncertain times:
Be sure you can afford the mortgage. The face value of the mortgage should be no more than 3 times your annual take home pay. Ideally, thatshould comefrom one spouse’s earnings only. Anotherformula, used by banks, suggests that monthly mortgage payments should not exceed 30% of the total gross monthly income.
Shop carefully. Choose the lending institution according to its interest rate, terms and reputation.
Make the largest down-payment you possibly can. No one wants to scrimp on new drapes and rugs, but remember the smaller your mortgage, the less it will ultimately cost you, and the smaller your monthly commitment.
An open mortgage. This way, the mortgage can be reduced at any time without penalty. If your Aunt Milly dies, leaving you a bundle, you may discharge the entire mortgage immediately. Or, if interest rates drop, you may discharge your mortgage and remortgage at the new lower rate. The open mortgage gives you flexibility, and therefore protection, in a volatile market. The interest rate will be higher.
Get the longest term possible. If you can get a 3-year term, open mortgage, you are protected against rising interest rates for 3 years before the rate is readjusted. However, if interest rates go down, theflexibleopen mortgage will allow you to discharge this mortgage for a less costly one.
Spread the debt over the shortest time your cash flow will allow. As this example illustrates, the length of time you hold the debt is directly related to cost.
A $50,000 mortgage, at 17%: Held for 20 years, payments would be $711 per month, total payment would be $170,640; held 25 years, $696 monthly, total payment, $208,800; held 30 years, $689 monthly, total payment, $248,040. Therefore, by paying only $7 per month extra, you reduce the total debt by $49,240. And paying $22 more monthly saves $77,400.
If possible buy based on one salary only, save any second salary to reduce your mortgage. Prepay whatever you can afford. A mortgage is a non-deductable debt. You are paying it with after tax dollars. Discharge your mortgage if ever possible; even paying a pen-
alty is worth discharging a debt paid with after tax dollars.
Have a “sinking” fund. Protect yourself by having at least 2 months’ mortgage money in savings or liquid form, in case of emergency. A lay off, pregnancy or major repair could ruin your budget.
Reduce credit cards or other debts. Examine your credit. Since most cards have an interest rate of 21%, they will cost you more than your mortgage. It is difficult for a homeowner to assume huge mortgage payments on top of large
credit card debts and may jeopardize your qualifying for a mortgage. If you cannot survive each month without your credit cards, you probably can’t afford the mortgage. Cut up the cards you don’t need, discharge all credit card debt, and roll your credit limit back to $500. Remember, credit should be used to even out fluctuating financial debts. If you need credit to get you through each month, you are falling behind and certainly can’t afford the additional burden of a costly mortgage.
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