For those with a variable mortgage, ever-increasing interest rates might make you feel like you’re caught in a game of chicken.
Do you swerve and switch to a fixed-rate or ride it out and wait for the Bank of Canada to lower their rates? Either way, you’ll want to adjust your monthly mortgage payments.
If you don’t, this easy to overlook error could add years to your amortization period.
Increasing your payments is necessary to cover off higher borrowing costs. While leaving your payments as is may seem like a tempting offer, failing to increase payments will result in your lender taking more of your payment to cover the interest, putting less towards the principal.
“Paying less principal now, means you have more principal on which the bank can charge you interest this month, next month and the month after,” writes Licensed Insolvency Trustee, Doug Hoyes.
And that, of course, means added time on to your amortization. Hoyes tells Toronto Storeys a 0.25 per cent increase on a $400,000 mortgage at 2.84 per cent could add 10 months of mortgage payments for a total of 310 months. That’s an additional $6,978 in interest over the life of the mortgage!
Hoyes goes on to say that since the maximum allowable length for a mortgage in Canada is 25 years. Some homeowners aren’t even allowed to keep payments the same. This, of course, can result in homeowners taking on other debt to cover monthly mortgage payments.
On the flip side, if interest rates were to suddenly drop, leaving your payments as is would be the smarter choice financially.
Even though it might be nice to get some extra money in your pocket now, consider this…
If you had a $350,000 mortgage with a 25-year amortization at 5 per cent interest you’d be paying about$2,036 monthly. If interest rates dropped to 4 per cent you could leave your payments as is and decrease your amortization to 17 years and 8 months or decrease your payments to $1,872 a month and continue paying it off for 20 years.
Of course, with five interest rate increases since June 2017, a one per cent drop seems like the impossible.
If you’ve already renewed your mortgage or locked in without adjusting your monthly payments, you can still make adjustments in preparation for future hikes and renewals by making lump sum payments.
Depending on your mortgage contract, the amount you can put towards your mortgage in addition to monthly payments will vary. If you exceed the amount, you may be required to pay a penalty fee. Contact your lender to discuss lump sum payments and penalties before making a payment.