Top Home Mortgage News

Your email:

 

When shopping for your next mortgage or your first mortgage, most people tend to gravitate towards mortgages that offer low interest rates instead of mortgages with strong features. Since banks mainly promote the interest rates when promoting it’s line of mortgage products, it is easy to conclude that a lower interest rate will provide you with maximum savings over the course of your mortgage term; however, this is not always the case. The following details why choosing a mortgage with a higher rate and better prepayments terms could save you more money in the short and long run.

A Low Rate Mortgage with No Special Features

The following mortgage is a low rate mortgage that is much lower than the general going rate for mortgages. It offers no prepayment privileges, no payment increases, and no ability to discharge your mortgage until the renewal date.
The following is the details of a standard mortgage:

Mortgage Amount: $300,000
Mortgage Rate: 3.50%
Amortization: 35 Years
Term: 5 Year Fixed Rate
Mortgage Payments: $1,235.49/month

At the end of the 5 year term, you will have a mortgage balance of $276,002.14 remaining on your mortgage. This is with fixed payments on a basic mortgage. In comparison we will look at a higher rate mortgage, with a person taking advantage of the mortgage prepayments.

A Mortgage with a Higher Interest Rate and Mortgage Prepayments

A mortgage is calculated with today’s dollars when you initial purchase the property and get the mortgage; however, the balance on your mortgage will decrease as you pay down your mortgage, the value of your property will most likely increase, and your income should steadily rise. In Canada, inflation has averaged 3.78% over the last 30 years, so it is expected that your income will rise by at least inflation. This means that on average you can pay at least 3.78% more than you could the previous year. If you steadily increase your payments to reflect the increases in income, then you will see the following:

Mortgage Amount: $300,000
Mortgage Rate: 3.80%
Amortization: 35 Years
Term: 5 Year Fixed Rate
Initial Mortgage Payments: $1287.30/month

At the end of the 5 year term, you will have a mortgage balance of $270,870.20 remaining on your mortgage. This is with fixed payments on a mortgage where the payments are increased with inflation. By using this method of increasing your payments for the first five years, you will reduce the amount of time it will take to pay off your mortgage by 8 Years and 10 Months. This also represents a savings of $64172.26 in interest.

By using this method, you will have your mortgage paid off in 244 months, while if you relied on a low interest rate mortgage, then you could be paying your mortgage for as long as 420 months. The additional 176 months in mortgage payments would result in an additional $217,446.24 in payments being paid towards your mortgage.
This is an amazing amount of money that the bank is collecting in additional interest from the mortgage holder.

The final factor to consider is what rate is the break-even point between a basic mortgage and a mortgage with prepayments.

Basic Mortgage Vs. Mortgage with Prepayments

To compare the two strategies by what is remaining after the term is complete, the one with prepayments will usually be the winner; however, in order to calculate what is paid in interest over the term to see what you are saving in interest, an amortization schedule must be reviewed.

Amortization Schedule for the Basic Mortgage

Totals:
Total Paid: $74,129.40
Interest Paid: $50,131.56
Principle Paid: $23,997.84

Amortization Schedule for the Prepayment Mortgage

Totals:
Total Paid: $83,302.20
Interest Paid: $54,172.40
Principle Paid: $29,129.80

Under these details, the prepayment mortgage is paying down the mortgage principle by an addition $5,131.96. As the mortgage gets smaller and smaller, the prepayment mortgage becomes more and more effective at reducing the interest paid. As stated previously, by using this method, you will save yourself 176 months worth of mortgage payments which will more than offset the slightly higher interest rate. In all cases, it is always better to choose a mortgage with good prepayment and payment increase terms over a lower interest rate.
If you do choose a mortgage with the prepayment option, then make sure you use it. Many people have this function, but they never use it. Make sure you do not make this same mistake.

Save your Mortgage from the Bank. Simply Mortgages can Help!

Welcome back!

Related posts:

1. Filologix Mortgage Calculators: How to use the Prepayment Analyzer Calculator? This calculator is one of the greatest tools that you...
2. Mortgage Features you should be Aware of Your email:  With banks competing harder and harder to win...
3. Monthly, Semi-Monthly, Bi-Weekly, or Weekly Payments; What is the Best Option for you? When setting up your mortgage, one surprisingly important question is...