First time mortgage questions

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qwimjim
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First time mortgage questions

Post by qwimjim »

Hi, just a couple of questions as this is my first time. We will be buying a $300,000 house with a $150,000 down payment. Is there any reason not to take a fixed 5 year variable rate mortgage right now? RBC is quoting me prime minus 0.60% = 2.25%. They said I can make a once a year 10% lump sum payment on the mortgage, and I can double monthly payments.. so say payments are $650/month I could contribute an additional $650 per month that would go towards capital. So that's around $23,000 a year I can pay down the mortgage ahead of schedule without penalty which is more than I would ever be able to pay it down in that time frame.

They said I could convert to fixed rate anytime I wanted, and if I wanted to sell my house and didn't purchase another house or need a mortgage anymore before the 5 year term is up, then the penalty would be 3 months interest or approx $850. They said there's also an interest differential penalty that can be levied but that's only usually done with fixed rate mortgages when the rates go down. They said with a variable 5 year it could only happen if the discount off prime increased and even then it would be small.

So do I have a pretty good understanding of what I'm getting into? Is there anything else I should know before getting a variable 5 year mortgage?

Also is there any reason to go with someone like true north financial instead of RBC which is offering prime -0.75 or 2.05%?

Thanks!
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Re: First time mortgage questions

Post by Just a Guy »

There is nothing wrong with variable mortgages unless rates go up significantly.

As for mortgages from other banks, read the terms. Not all mortgages are set up the same way. Repayment amounts, payment frequency, penalties, etc. all can change. If the terms are the same, then it doesn't matter which lender you use.
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Re: First time mortgage questions

Post by adrian2 »

qwimjim wrote:RBC is quoting me prime minus 0.60% = 2.25%.

[...]

Also is there any reason to go with someone like true north financial instead of RBC which is offering prime -0.75 or 2.05%?
Both deals are very good. Go get it!
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Re: First time mortgage questions

Post by HardWorker »

The discussion on variable vs fixed is long, and dependent on each individual's situation. If you can stomach (and able to pay) a possible rate hike in the future, then you'll likely to save money going with variable.

True North is a broker, and not a lender. I used them for my current mortgage, and no issues at all. Smaller lenders pretty much always have better rates, lower fees, and more prepayment privileges. I personally see no reason to go with the big banks at all, but that's just own my situation, and one size doesn't fit all.
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Re: First time mortgage questions

Post by Peculiar_Investor »

It sounds like the OP has done a lot of homework and has a pretty good understanding. To add some further ideas, our wiki has some helpful information, see Mortgage and in particular the FWF discussions section links to previous discussions that might be helpful to review.

I haven't had a mortgage in a long time, but I do recall the issue of whether the mortgage registration will be a Standard charge or a Collateral charge is important to consider and understand.

Also make sure you understand how the interest rate differential works. IIRC, there have been previous posts that mention is it based on the posted rates, not the discounted rate you make negotiate.

Back in the day (circa mid 80s) when we first purchased a house and got our first mortgage, we started with a fixed 5 year term and generous pre-payment options such as double-up. Our rationale was it was worthwhile to accept a higher interest rate to have the security in knowing the payment amount was fixed over the first mortgage term. Regular repayment of debt was a new concept to us, we were both starting new jobs and didn't have a lot of job security. So the security of a fixed rate over a known time period was important and valuable to us. We also took advantage of regularly making double-up payments when we had extra cash flow, this significantly shortening the amortization period, and thus substantially reducing our overall interest costs. In hindsight, a variable rate mortgage would have saved us more, but we didn't want to risk being penny wise and pound foolish.
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Re: First time mortgage questions

Post by dougboswell »

You need to ask a couple of more questions from RBC. Ask them if this mortgage is being registered as a collateral (probably yes) and ask what the pros and cons of a collateral are compared to a standard. With a collateral, if you ever decide to move to a different lender ( ie: you want to switch at the end of your 5 year term) you will have to pay lawyer's fees to have it discharged ($750 - $1000 these days).

If you are in a 3 or 5 year variable most lenders let you switch to a fixed mid-term. However if you are in the 2nd year of a 5 year and want to switch they will not convert you to a 3 year fixed to complete the term but it has to longer than the 3 year. More importantly you do not keep your variable rate but are given a fixed which could higher than the variable as fixed rates will start to rise at some point.

Do your due diligence before signing and read everything carefully before signing. Do not just sign on the dotted line.

There is an article in the Globe and Mail by Rob Carrick which talks about the big banks and what exactly they are offering:

http://www.theglobeandmail.com/globe-in ... e23526054/
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Re: First time mortgage questions

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dougboswell wrote:You need to ask a couple of more questions from RBC. Ask them if this mortgage is being registered as a collateral (probably yes) and ask what the pros and cons of a collateral are compared to a standard. With a collateral, if you ever decide to move to a different lender ( ie: you want to switch at the end of your 5 year term) you will have to pay lawyer's fees to have it discharged ($750 - $1000 these days).

If you are in a 3 or 5 year variable most lenders let you switch to a fixed mid-term. However if you are in the 2nd year of a 5 year and want to switch they will not convert you to a 3 year fixed to complete the term but it has to longer than the 3 year. More importantly you do not keep your variable rate but are given a fixed which could higher than the variable as fixed rates will start to rise at some point.

Do your due diligence before signing and read everything carefully before signing. Do not just sign on the dotted line.

There is an article in the Globe and Mail by Rob Carrick which talks about the big banks and what exactly they are offering:

http://www.theglobeandmail.com/globe-in ... e23526054/

Thanks this is all very helpful! It's hard to know about all the potential red flags and issues to look out for, if anyone has anything else to ad please do
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Re: First time mortgage questions

Post by dougboswell »

The points I raised in my first post are red flags that the big banks do not talk to you about unless you know to ask those questions.
Whether to go with a variable or not basically comes down to your level of risk tolerance. A 5 year fixed gives you piece of mind and you know exactly what your payments will be. If you have extra cash you can make prepayments up to the annual allowable amount.

Variable mortgages do carry risk in that if and when the Bank of Canada raises its prime rate the variable rate will rise also. At some point your monthly payment will rise also,

If you don't mind risk and can sleep at night variable may be the answer. If you would be laying awake at nights worrying about if you can afford any new increase in monthly payments then fixed would be better for you.

Interest rates will rise but no one can predict when. Bank economists, mortgage agents and financial garus cannot say accurately when.

Remember it will only take 2 or 3 bumps in interest rates over the next 5 years and your variable rate will be costing more than the fixed rate if you take it now.
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Re: First time mortgage questions

Post by longinvest »

qwimjim,

When we bought, we took a fixed 10-year mortgage with 10-year amortization. At the time, the 10-year fixed rate was higher than the 5-year fixed rate, which in turn was higher than the 5-year variable rate. Had we taken the 5-year variable, we would have enjoyed declining variable rates, yet we have no regrets as the higher rate motivated us to pay down the debt as fast as possible. We ended up paying the mortgage much quicker than 10 years, significantly reducing the amount of interest paid (that was a lot of money saved).

Let me project what we did in today's environment. We are comparing a 3.65% 10-year fixed rate to a 2.1% variable rate. Amortizing $150K on 10 years:
  • 10-year fixed: $1,491.91/month
  • 5-year variable: $1,386.31/month
That's a $105.60 difference per month. Over 120 payments, it's a $12,672 difference, assuming no prepayment. For reference, in our case, the difference was $160/month. The quicker one pays, the less impact the interest rate has on total interest paid.

If I was to amortize on 25 years, I would definitely try to keep the interest rate as low as possible, balanced with the risk of losing sleep. When we bought, we amortized on 10 years and gave the highest consideration to the sleep factor.
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Re: First time mortgage questions

Post by qwimjim »

Thanks, a $150,000 mortgage amortized over 25 years as payments would only be $639/month so we definitely wouldn't be losing any sleep there. On a 10 year amortization we would be paying $1,383/month which we could afford but it would be squeezing our budget once we factor in an extra $500/month for taxes/heat/hydro and the $1,500/month for TFSA/RRSP/RESP contributions.

What about taking a 25 year amortization but lump summing the equivalent of a years worth of payments ($7,668) so it's like the equivalent of doubling the payments each month which would be in line with the 10 year amortization monthly payments.. would that be wise? That way we have the luxury of only paying $639/month if ever we have financial difficulties in the future (loss of employment, injury, health, etc)? Or would we end up paying more interest this way?

Or if we're not worried about being able to make payments for the 5 year span of the term we could take the 10 year amortization and if we hit hard times refinance to a 15 or 20 year amortization to lessen the payments when it comes time to renew? from what I understand this would incur lawyer fees of about $500?
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Re: First time mortgage questions

Post by Spudd »

I always liked taking the longer amortization and then paying extra on it. The limits imposed on extra payments are usually quite generous, and it gives one the flexibility to cut back to a lower payment if one were to lose one's job. I don't think you pay any extra interest this way, as long as the total payments with the longer amortization are equal to those you would have with the shorter amortization.
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Re: First time mortgage questions

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Spudd wrote:I always liked taking the longer amortization and then paying extra on it. The limits imposed on extra payments are usually quite generous, and it gives one the flexibility to cut back to a lower payment if one were to lose one's job. I don't think you pay any extra interest this way, as long as the total payments with the longer amortization are equal to those you would have with the shorter amortization.
You're right I did the math and if I take a 25 year amortization and at the end of the year lump sum the difference between my 25 year amortization payments ($639/month) and what I would have paid had I taken a 10 year amortization (($1,383/month - $639/month) X 12 = $8,928) then I end up paying the same amount of interest and pay off the mortgage in 10 years.. doesn't cost me anymore but gives me more flexibility.

So really it seems like there's absolutely no reason to take anything but a 25+ year amortization, if you take a 10 or 15 year all you're doing is locking yourself into the higher payment for 5 years which could become a problem if something loses a job, gets sick or injured, etc.. Seems like there's zero downside to take the 25 year amortization and just paying it on a 10 year payment schedule unless you lack the discipline to stick to it.

Or am I missing something?
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Re: First time mortgage questions

Post by longinvest »

qwimjim wrote:Thanks, a $150,000 mortgage amortized over 25 years as payments would only be $639/month so we definitely wouldn't be losing any sleep there. On a 10 year amortization we would be paying $1,383/month which we could afford but it would be squeezing our budget once we factor in an extra $500/month for taxes/heat/hydro and the $1,500/month for TFSA/RRSP/RESP contributions.
We didn't have to squeeze our budget to amortize on 10 years (but we had to budget). You could possibly consider amortizing on 15 years. I wouldn't pay the extra interest for a 10-year fixed mortgage, in that case. I would stick with a competitive 5-year fixed or variable rate, based on sleep factor.
What about taking a 25 year amortization but lump summing the equivalent of a years worth of payments ($7,668) so it's like the equivalent of doubling the payments each month which would be in line with the 10 year amortization monthly payments.. would that be wise? That way we have the luxury of only paying $639/month if ever we have financial difficulties in the future (loss of employment, injury, health, etc)? Or would we end up paying more interest this way?
Your calculator is probably as good as mine. If you pay as much money, each year, it should be pretty close. You'll probably pay a little more interest than through monthly payments, but not enough to make any significant difference.

If you get a mortgage amortized on 15 years, you're more likely to pay it in 15 years or less than if you amortize it on 25.
Or if we're not worried about being able to make payments for the 5 year span of the term we could take the 10 year amortization and if we hit hard times refinance to a 15 or 20 year amortization to lessen the payments when it comes time to renew? from what I understand this would incur lawyer fees of about $500?
Personally, I wouldn't risk taking a mortgage that squeezes my budget. Life happens, even more so when one has a house. I would keep a budgetting buffer between me and my obligation to the bank, just in case.
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Re: First time mortgage questions

Post by pmj »

Dunno what other lenders do, but ScotiaBank calculates two-weekly payments as 50% of the true monthly payment. This by itself represents about one extra monthly payment per year. And two-weekly payments nicely match most paycheques!
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Re: First time mortgage questions

Post by qwimjim »

So lack of discipline is the only reason to amortize for less than 25 years, because taking a 10 or 15 year amortization forces you to pay your mortgage down faster whereas if you take a 25 year with the intention of paying it off in 10 or 15 years you might not actually follow through because you don't -have- to?
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Re: First time mortgage questions

Post by longinvest »

For us, it was the flexibility to pay quicker that required a shorter amortization. It's unlikely for a 25 years mortgage to give enough flexibility to pay off a mortgage in 8 years through regular payments. There will be prepayment limits. Of course, one could make lump sum payments at the time of renewal, but the interest cost of delaying prepayments is high in early years.

There's no single best approach; it's very personal. It comes down to one's dislike for debt and ability to prepay.
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Re: First time mortgage questions

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longinvest wrote:For us, it was the flexibility to pay quicker that required a shorter amortization. It's unlikely for a 25 years mortgage to give enough flexibility to pay off a mortgage in 8 years through regular payments. There will be prepayment limits. Of course, one could make lump sum payments at the time of renewal, but the interest cost of delaying prepayments is high in early years.

There's no single best approach; it's very personal. It comes down to one's dislike for debt and ability to prepay.
Hmm, I looked at two offers. RBC offered the ability to pay 110% more per month towards your principal and additional lump sum 10% per year, which means you could definitely pay off your mortgage in 8 years despite a 25 year amortization. And through a broker I found and even lower rate which allowed for 20% lump sum payment per year, so you could pay it off in 5 years if you wanted, despite a 25 year amortization. So the longer amortization doesn't seem to prevent one from paying their mortgage off quickly.

The additional cost in interest is negligible, on a $300,000 mortgage if you take a 10 year amortization the monthly payment is $2,767/month. With 25 year amortization it's $1,279/month. With RBC you can pay an additional $1406 per month towards your principal so at the end of the year you need to make a lump sum payment of $984 to keep up with the 10 year schedule, which will result in a difference in interest payments of $1.08 per year :)

So correct me if I'm wrong but I still don't see a single good reason to opt for a 10 or 15 year amortization period. It doesn't give you more flexibility, it gives you less?? With a 25 you have the flexibility to pay your mortgage off as fast as you want (as long as it isn't faster than 5 years), you can still get the lowest interest rates on the market, and you have a safety net of a significantly smaller "minimum" payment should you ever fall on hard times.

What am I missing?
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Re: First time mortgage questions

Post by longinvest »

You did your homework and found something that will work for you. You're not missing anything.
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Re: First time mortgage questions

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longinvest wrote:You did your homework and found something that will work for you. You're not missing anything.
Right, but under what circumstances would it not work for someone else? I'm genuinely curious, it seems like there's no advantage whatsoever, it's just more limiting.
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Re: First time mortgage questions

Post by Spudd »

I guess most people just don't think it through.
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Re: First time mortgage questions

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qwimjim wrote: Right, but under what circumstances would it not work for someone else? I'm genuinely curious, it seems like there's no advantage whatsoever, it's just more limiting.
It is my opinion that it is much riskier to get a mortgage with unknown terms than a mortgage with all known terms.

With a 25-year amortization 5-year mortgage, I accept to assume a debt obligation with unknown parameters. In particular, I only get to know the interest rate for the first 5 years and I am exposing myself to the risk of significantly higher rates at the end of the initial 5 years. Also, I do not have any control over renewal terms and mortgage-renewal costs.

When I get a 10-year amortization 10-year mortgage with a reasonable fixed rate, I get to know all of the debt repayment terms. While it might be costlier, it is less risky as long as I have the means to meet the repayment terms even if adverse events happen in my life.

Ramblings on risk:

If I was to ignore risk, my calculator would tell me that I should take as big a HELOC as possible and invest it all in the stock market (as I am not averse to portfolio volatility), and get to deduct the interest from my taxes. But, the definition I like for risk is not volatility; it is "doing badly in bad times" (William Sharpe).

Having no mortgage payment means that I need very little income to meet all my recurring monthly/yearly financial obligations (electricity, internet and phone, municipal taxes, etc.). Detailed research has been done and they found that 100% of home foreclosures happen on homes with a mortgage (Dave Ramsey).

Your mileage may vary.
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Re: First time mortgage questions

Post by qwimjim »

longinvest wrote:
qwimjim wrote: Right, but under what circumstances would it not work for someone else? I'm genuinely curious, it seems like there's no advantage whatsoever, it's just more limiting.
It is my opinion that it is much riskier to get a mortgage with unknown terms than a mortgage with all known terms.

With a 25-year amortization 5-year mortgage, I accept to assume a debt obligation with unknown parameters. In particular, I only get to know the interest rate for the first 5 years and I am exposing myself to the risk of significantly higher rates at the end of the initial 5 years. Also, I do not have any control over renewal terms and mortgage-renewal costs.

When I get a 10-year amortization 10-year mortgage with a reasonable fixed rate, I get to know all of the debt repayment terms. While it might be costlier, it is less risky as long as I have the means to meet the repayment terms even if adverse events happen in my life.

Ramblings on risk:

If I was to ignore risk, my calculator would tell me that I should take as big a HELOC as possible and invest it all in the stock market (as I am not averse to portfolio volatility), and get to deduct the interest from my taxes. But, the definition I like for risk is not volatility; it is "doing badly in bad times" (William Sharpe).

Having no mortgage payment means that I need very little income to meet all my recurring monthly/yearly financial obligations (electricity, internet and phone, municipal taxes, etc.). Detailed research has been done and they found that 100% of home foreclosures happen on homes with a mortgage (Dave Ramsey).

Your mileage may vary.
Yes but you're talking about interest rate terms not amortization. You did not have to lock yourself into a 10 year amortization to accomplish the above, you could have taken a 25 year amortization with a 10 year fixed interest rate term, and simply paid more per month and/or with lump sums so that you were following a 10 year amortization payment schedule. You would have paid off the mortgage in the exact same amount of time, costing you the same amount of money, with the comfort of knowing exactly how much your payments would be for those 10 years BUT with the added bonus of being able to drastically reduce your monthly obligation should your family fall on hard times.

Again, it really seems there is no advantage to a shorter amortization?
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Re: First time mortgage questions

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You're ignoring the hassle factor.

I know that if I do nothing, the bank will take its regular payments and my 10-year amortization 10-year mortgage will pay itself in 10 years.

When we did additional lump sum payments, I had to talk to the bank lady, and fight to get things done correctly (I guess that the bank didn't like us to pay much faster than scheduled, I don't know why). I am a numbers guy; I like to precisely calculate everything and I'm usually not so bad at it. Yet, I never was able to reconcile the bank's interest calculation on my lump sum payments. The bank's calculation (or mine) was always a off by few dollars (less than $5 on multiple-thousand dollars lump sums). I ended up being too lazy to make a fight about it (wouldn't be worth my time), but it goes to show that things are not as smooth as you might think when one gets off the initial schedule.

Actually, on my final lump sum payment (mortgage burning), the bank lady screwed up things badly and got the bank to take one extra payment at the start of the next month. Fortunately, we had enough money in our joint bank account, but we almost had a few regular bill payments bounce; the account got down to less than $10! For this one, I actually fought and got the bank to pay us back the money with the same interest rate we had been paying on the 10-year mortgage. :evil:
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Re: First time mortgage questions

Post by qwimjim »

longinvest wrote:You're ignoring the hassle factor.

I know that if I do nothing, the bank will take its regular payments and my 10-year amortization 10-year mortgage will pay itself in 10 years.

When we did additional lump sum payments, I had to talk to the bank lady, and fight to get things done correctly (I guess that the bank didn't like us to pay much faster than scheduled, I don't know why). I am a numbers guy; I like to precisely calculate everything and I'm usually not so bad at it. Yet, I never was able to reconcile the bank's interest calculation on my lump sum payments. The bank's calculation (or mine) was always a off by few dollars (less than $5 on multiple-thousand dollars lump sums). I ended up being too lazy to make a fight about it (wouldn't be worth my time), but it goes to show that things are not as smooth as you might think when one gets off the initial schedule.

Actually, on my final lump sum payment (mortgage burning), the bank lady screwed up things badly and got the bank to take one extra payment at the start of the next month. Fortunately, we had enough money in our joint bank account, but we almost had a few regular bill payments bounce; the account got down to less than $10! For this one, I actually fought and got the bank to pay us back the money with the same interest rate we had been paying on the 10-year mortgage. :evil:
Well let's not forget you're working with a sample size of one :) Your experience could very well be exceptional. Regardless, the potential for such hassles hardly seems like a reason to lock oneself into a 10 year amortization and give up the flexibility of being able to halve ones monthly mortgage payment should you hit hard times.

If anyone can think of anything else please share, I'm sure this thread will be helpful to someone down the line
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Re: First time mortgage questions

Post by longinvest »

You're really looking at it from your own point of view, which is fine actually, as you found the best solution for you.

I won't give you our exact numbers, but I can assure you that had we chosen the same mortgage but on a 25-year amortization schedule, we wouldn't have been able to prepay it as fast as we did without having to pay penalties. We worked hard at getting the lowest possible 10-year mortgage interest rate, which probably limited the prepayment flexibility.
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