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House mortgage payments (Photos.com)
House mortgage payments (Photos.com)

Decoding the mortgage market

Pay your mortgage like it’s 2007. You'll save a pile of money Add to ...

Just 60 short months ago, mortgage rates were double what they are now. That means payments on a 25-year mortgage of equal size were 36 per cent higher than today.

Since then, the amortization gods have slashed mortgage rates and payments. Compared to interest costs in 2007, today’s rates would save you $101,700 if projected out over 25 years on a $200,000 mortgage.

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If you look at the payments on a mortgage that size, they’ve tumbled from $1,284 in 2007 to $945 today. (To put that in perspective, the payment at zero per cent interest would be $667.)

It’s clear that the savings potential of today’s rates is phenomenal. The question is: are Canadians taking advantage of these record-low rates?

The answer? Not enough. About 60 per cent of mortgage holders make only their minimum mortgage payment, finds the Canadian Association of Accredited Mortgage Professionals.

But what would happen if people made their payments at the 2007 level?

If applied today, that higher $1,284 payment would knock an extra $21,900 off your principal in five years. You would also save $1,600 in interest and retire your mortgage in two-thirds the time.

Switching to bi-weekly 2007-style payments - $642 every two weeks in this example - means you would pay off that 25-year mortgage in 14.8 years. The five-year interest savings would jump to $2,100.

To replicate interest savings like that, you’d have to chop a quarter per cent off your interest rate. And negotiating another quarter-point reduction on a deep-discount rate can be tougher than sucking sap through a straw.

“Canadians have a legacy of focusing on rates as the primary means to save on the cost of borrowing,” says David Stafford, managing director of real estate secured lending at Scotiabank. “That’s where all of the time and effort is being invested.”

“But the actual cost of a mortgage is based on how much you borrow, at what rate, and for how long,” adds Mr. Stafford, who inspired the calculations above. “And with rates well below recent historical averages, the best way to save money on a mortgage is to use today’s low rates to shorten the amortization.”

Of course, paying extra isn’t easy or everyone would be doing it. Some folks are running too close to the financial edge to bump up payments. Others have more pressing needs for their extra cash. And the rest could pay more if they wanted to, but choose not to.

Looking forward, the leaves in my teacup suggest we won’t see 2007-style rates again for a while, but I can’t definitively predict that. Nor can anyone else.

What we do know is that rates are cyclical. They move like a roller coaster. Right now we’re at the bottom of a valley with an incline off in the distance.

When rates ride the escalator back up, the ascent could theoretically take us back to 2007 levels. So prospective mortgage holders need to ask themselves: Would I buy the same price house if I had to make payments that were 36 per cent higher? Would I get the same size mortgage if rates were double today’s rates?

If the answer is no, they probably shouldn’t be in that mortgage today.

If you’re a mortgage holder with other high-interest debt or higher returning investments, or you have no emergency fund, you may want to divert your cash to those objectives. Otherwise, if you want a respectable low-risk return, increasing your mortgage payments fits the bill.

“An extra dollar paid at the beginning of a mortgage is a dollar you’re not going to pay interest on for the next 20-30 years,” Mr. Stafford says. “And making a payment that’s more reflective of historical rates also has another added benefit – you future-proof yourself from payment shock if rates are back at six per cent five years from now.”

Robert McListeris the editor of CanadianMortgageTrends.com and a mortgage planner at Mortgage Architects. You can also follow him on twitter at @CdnMortgageNews.

 
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