After years of waiting and planning, you are getting ready to purchase your first home. But before you make your final choice, you have to determine your budget and find a great mortgage rate.
Most lenders today want to provide competitive rates, so they throw a lot of information your way on discounted interest rates for 3-year, 4-year, 10-year, or the ever-popular 5-year mortgages. You also hear about variable and fixed rates.
With so many percentages swirling in your head, it’s easy to be confused. Do you really need that rock-bottom interest rate to get the best deal on your mortgage, or do other factors matter more?
Here are 3 things you should know before you sign the mortgage papers and lock into a given interest rate.
1) Factor in life events
That 2.99% discounted mortgage rate for a 5-year fixed plan may seem quite appealing if you can only pay the minimum down payment and are planning to stick around for 5 years.
However, life events can change quickly. You may lose your job or transfer to another city. You might start a family. Even if you anticipate few changes, you may not be prepared for the reality of your monthly mortgage payment, particularly if you are locked in to your rate.
That said, if you feel your job is relatively secure and you have no plans to move, your 5-year mortgage at the discounted rate may make sense for you. If you are a great budgeter, you may opt to improve your situation even more by splitting your payment. By paying twice a month, you contribute even more to your principal costs.
2) Understand the fine print
If you are only concentrating on getting the lowest possible mortgage rate, you might neglect the finer points of your mortgage. If you have to move before those 5 years are up, you will be stuck paying thousands in payout penalties. Although most reputable lenders will tell you about potential penalties up front, in your excitement over your new home, you may miss the details.
First, understand that your lender makes a living from those interest rates and fixed penalties. To calculate the penalty, your lender uses an interest rate differential, or IRD. The IRD simply means you’ll pay a penalty on the greater 3-month interest rate.
For example, if your mortgage is $200,000 and your mortgage rate is 3.0% at the time you break your mortgage agreement, your 3-month interest would be $1,500. However, the actual penalty on that interest can vary. Here’s how most lenders calculate the penalty costs:
- Your lender chooses a standard IRD using the difference between your 3.0% rate and a common rate for the 2 years remaining in your loan term.
- Your lender applies your initial discount to the above standard IRD. Ironically, this inflates the penalty you owe.
- Your lender uses the same rate they offered when you received your new mortgage. This is called a posted-rate IRD. Many lenders use this penalty rate. This is the most expensive penalty of all.
Confused? No wonder. It’s a complicated process, even if you are a math whiz. Ask your brokers how each lender calculates early-payout penalties on 5-year fixed mortgages. You will be happy you did, even if you don’t have to break your mortgage agreement.
3) Pay attention to mortgage type (and length) as well as rate
It’s not unusual for home buyers to fixate on the mortgage rate, to the exclusion of many other important details. Don’t get so bogged down on the lowest numbers that you forget to look at the benefits or disadvantages to typical mortgage types. And by types, we mean variable versus fixed.
Ever since the global meltdown of 2008, homeowners have been particularly leery of variable-rate mortgages. While variable rates do involve risk, they may work for you if the following factors are true:
- You have a risk-tolerant personality.
- Your income can tolerate fluctuating mortgage rates during the term of your loan.
- You decide to set your rate higher than the minimum, accounting for higher rates that may come later.
- You plan to pay more than your monthly minimums so you are eligible for pre-payment privileges (locking to the current rate for the rest of your payment term after interest rates start to rise).
That said, if you’re a worrier or someone who can barely meet monthly payments, a variable-rate mortgage probably isn’t for you.
One reason why fixed-rate mortgages are so popular in Canada is because of the latest interest trends. If the variable rate is currently about 3% and you can get a fixed-rate product for 3.5%, your savings isn’t enough to warrant the variable rate anyway.
Most homeowners need the stability of a fixed rate, particularly in the current economy. Even at a higher interest rate, a fixed loan gives you a sense of security in tumultuous times.
If you are not sure which kind of loan is best for you, have your broker compare monthly payments and see what you can afford.
Finally, ask your mortgage broker what term length makes the most sense in your situation. 5 years is average, but if you need more flexibility, you do have options. Make the choice that works best for you.
Contact The Mortgage Centre in St. John’s serving Mount Pearl, Paradise, Conception Bay South, Gander, Springdale, Corner Brook or Clarenville, Newfoundland to speak with an expert today 709-739-6400.