When you purchase a home, you are most likely investing in the largest asset that you will ever own. Likewise, you are probably also taking on the largest debt you will ever have. The following is not intended to discourage home ownership. In fact, for many, it is the best financial decision they will ever make.
A home is so much more than just a financial decision; it is the place where you will spend a fair part of your life. A place where families are raised and memories created. However, most people don’t realize what the true cost of their home is. This can be best illustrated with an example of a pretty average scenario.
Consider a young couple who purchase a home and secure a $250,000 mortgage at an interest rate of 5% amortized over 30 years, which would create a monthly payment of $1,334 a month. I beg you not to state that 5% is too high an interest rate based on the rates being offered today. Five per cent is a very reasonable rate to use over a 30-year period and if anything is on the low side for a 30- year average. Check out the Bank of Canada site to see the average posted five-year fixed rate from 1951 to present , What you will see is that rates have not spent much time below the 5% mark.
Going back to our example, it is shocking to learn that the $250,000 mortgage as noted above actually has interest costs of more than $230,000. So when we consider the true cost of what was actually paid for the home we must add the down payment plus $480,000 (principal and interest cost).
For this example, let’s say that the purchasers put down 20% and were left with a $250,000 mortgage. This means a home that cost $312,500 and required a down payment of 20% or $62,500, plus the $480,000 of principal and interest charges over the life of the mortgage, results in the true cost of the $312,500 home being $542,500.
So now that I have shed some light on the true cost of a mortgage, this doesn’t mean there is reason to be too upset. The bright side of all of this is that there are many actions you can take which are especially effective in the early years of a mortgage that can dramatically reduce interest costs.
The first is to increase your monthly payment. In the above example, increasing your monthly payment from $1,334 to $1,454 reduces your amortization from 30 to 25 years. This is such a small sacrifice when you look at the benefits. Yes you are paying an extra $120 a month, but you save a whole five years of paying the $1,334. Think about that; $1,334 multiplied by 60 months (five years) is $80,040, not to mention all that you could do with an extra $1,334 a month for five years.
Most mortgages not only come with the benefit of allowing you to increase your regular payment by up to double, but many also allow lump-sum payments annually that go directly to principal. Consider again the above example, but this time you have some extra money and you are not sure what you should do with it. Let’s say this extra amount is $5,000. In this case, if you put $5,000 down on your mortgage in the early years you will take off more than a year in payments.
Let’s say that the likelihood of having an extra $5,000 burning a hole in your pocket is not a likely scenario for you. In this case, consider switching your payments from monthly to weekly or bi-weekly. This is a great autopilot tactic to produce the same effect as putting down the $5,000 lump sum, meaning in both scenario’s you will eliminate five years worth of payments. The weekly or bi-weekly payments schedule actually sneaks an extra payment per year (roughly) from you, which ends up reducing the number of years you have to pay you mortgage.
There are a number of small changes or combinations of changes that you can make to pay off your mortgage sooner and pay less in interest. Talk to your mortgage broker and ask for some advice. It could save you thousands.
Jed Levene is a founding partner with Georgian Bay Financial Inc., a planning and investment/ insurance firm serving our area. He can be contacted at firstname.lastname@example.org.
Mortgage Man – Dominion Lending Centres | Ph: 705-326-8523 | Fx: 705-326-8645 | www.markgoode.ca | FSCO# 12254 | 180 Memorial Avenue | Orillia, ON L3V 5X6 |
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