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(Ryan McVay)
(Ryan McVay)

Rob Carrick

The end is nigh for low-interest-rate heaven Add to ...

Mark June 1 on your calendar if you have a variable-rate mortgage.

If you have a 35-year amortization and put down only 5 per cent when you bought your home, then be extra diligent about noting this date. Let things slide and you might be amazed at how much longer it takes to pay off your mortgage.

With the economy showing signs of rebounding, there's growing speculation that June 1 will be the day the Bank of Canada begins the coming cycle of interest-rate increases. Whenever this happens, it's back to the real world for variable-rate mortgage holders after almost three years in low-interest-rate heaven.

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Is this a good time to lock in or refinance your mortgage?

If you have a fixed-rate mortgage, you're immune to rate increases until renewal time. (Note that Royal Bank, Toronto-Dominion Bank and Laurentian Bank said they would raise their rates on five-year, closed, fixed-rate mortgages effective today.) With a variable-rate mortgage, however, your rate is adjusted up or down with each movement in the prime lending rate. The prime is influenced by the Bank of Canada's overnight rate, which will be set eight times in 2010. The next rate announcement is scheduled for April 20, and the ones after that happen June 1, July 20 and Sept. 8.

If you have a variable-rate mortgage but you don't have a plan, you're going to live and die by these dates.

Let's assume that you don't intend to use the provision that allows a variable-rate mortgage to be converted into a fixed-rate loan without penalty. Variable-rate mortgages usually cost you less interest over the long term, so this decision is certainly defensible.



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A first step in preparing for higher rates is to ask your lender what will happen to your mortgage payments when the prime rate starts to increase.

Vince Gaetano, a mortgage broker and vice-president at MonsterMortgage.ca, mentioned two possibilities. The first is that your lender will adjust your payments higher to cover the increased interest costs and stay within the amortization period you selected when you arranged the mortgage. If your mortgage works this way, all you have to do to prepare for higher rates is clear some room for higher payments.

The second possible result of higher rates is that nothing will happen to your payments. In other words, you're on your own. "The lender won't do anything until negative amortization kicks in," Mr. Gaetano said.

Negative amortization means your payments aren't enough to cover the interest you owe. Whatever extra interest there is gets tacked onto your principal, thereby increasing both what you owe and the payback period for the mortgage.

Even without negative amortization occurring, you can still add years to the payback period. Mortgage broker Jake Abramowicz ran some projections and found that an extra 10 years or more is possible.

There's extra urgency here if you have a 35-year amortization and you made the minimum 5-per-cent down payment. If rates rise substantially and you don't increase your payments, you could be knocking off just a few dollars of principal every payment. "People might as well be paying rent," Mr. Abramowicz said.

There's a third group of variable-rate mortgage holders out there - those who had their payments pegged to the rate of a three-year fixed mortgage. Note: Lenders have traditionally made sure you could afford the higher three-year rate before selling you a variable-rate mortgage. Starting April 19, they'll have to use the posted Big Bank five-year rate.

If you've been making higher-than-needed payments on a variable-rate mortgage, then you've done yourself a huge favour in terms of chipping away at your principal. Just remember that unless you keep tabs on rates, a sustained rise in borrowing costs could remove your cushion and slow your repayment process down.

The simple solution is to bump up your payments to cover off the extra interest cost. Typically, you can increase your regular payments by up to 100 per cent in a year. If you want to pay even more, try a lump sum or use the double-up payments that some lenders allow you to make when it suits you (it's not necessary to pay exactly double your normal payment, by the way).

Mr. Gaetano said that even if the payments on your variable-rate mortgage remain unchanged as rates rise, you'll still receive notices from your lender each time the prime rate rises. This ain't junk mail, people: It's a warning you could slowly be falling behind in getting your mortgage paid off.

Want to avoid the hassle of rate watching? There's always the option of switching to a fixed-rate mortgage. Mr. Abramowicz's take on this idea: "It's never a bad idea to lock in under 4 per cent [for five years]" Rates are going up, so hurry.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance

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Elevator going up

What can happen to a variable-rate mortgage when rates rise and the monthly payments stay the same:

Your current variable-rate mortgage

Details: $200,000 amortized over 35 years, monthly payments, semi-annual compound interest at 1.75 per cent Payments: $636/month Breakdown: principal = $345 and interest = $290

If Prime rises by 1 percentage point and your rate rises to 2.75 per cent

Payments: $636/month

Breakdown: principal = $180 and interest = $455

New amortization: 46 years

Source: Jake Abramowicz, Mortgage Edge

Follow on Twitter: @rcarrick

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