How can matters become even more tumultuous for those holding variable-rate mortgages?
If you answered an increase in price—you are surprisingly incorrect. Instead, the far bleaker scenario is stagnant payments that don’t increase adjacent to higher borrowing costs. Unchanging payments are a sign that lenders are using a higher percentage of your payments for hiked interest costs while applying less against principal.
Your period of amortization is how long it takes to pay off your mortgage. This period ideally would shrink consistently while you keep up with your payment schedule. However, when the bulk of your payment is being used to cover interest costs as opposed to the principal, it sends the mortgage process into a screeching halt. Suddenly, in lieu of making extra payments you’ll be dealing with a drastically longer mortgage.
A client of Jason Heath, a local Financial Planner, was shocked when his amortization period was extended as a result of rates rising 1.25% since summer 2017.
Variable-rate mortgage holders feel the brunt of increased amortization length during renewal times, when the majority of lenders often bump payments up significantly, according to Sandra Epstein, a mortgage consultant.
Lenders take the amortization period during renewal which is in line with the number of years you’ve began with, and subtract the number of years that have passed. Provided an errant amortization must be re-jigged upon renewal it will be accompanied by higher payments.
Variable-rate mortgages are misleading, as they come in different forms: one version which ensures level payments while rates change and another that is an adjustable rate mortgage which is the ideal choice when setting up a variable-rate mortgage.
Adjustable rates shift your interest rates and mortgage accordingly whenever your bank changes the prime rate.
Many mortgage lenders provide adjustable-rate mortgages where payments and interest rates will parallel one another when they change. Unfortunately, there are still far too many banks and credit unions hawking level payments mortgages. And guess what—when the rates are on the rise, the payment is used towards the interest.
According to a recent report, 28% of all mortgages in Canada are variable-rate, with 4% being variable-fixed hybrids while rest are fixed-rate.
While interest rates were decreasing throughout the past several decades, variable-rate mortgages came with lower borrowing costs compared to fixed-rate mortgages. Now, in the face of rising rates, mortgage-holders need to know the facts about fixed-rate mortgages.
Five years ago, variable-rate mortgages were based on a prime rate of 3% (or 2.5% if you’ve received a good deal). The best price you could get nowadays is 2.85% based on a 3.95% prime, which compares with 3.6% on a discounted five-year fixed-rate mortgage.
Unfortunately, you’re getting it from both sides because regardless of fixed or variable rates, you’re still dealing with a higher rate at renewal.
Lenders aim to level out owing and amortization when it’s time for mortgage renewals. If your rate of pay didn’t vary as rates increased, you’ll likely be stuck with higher rates against a balance with a decidedly less dent than you’d have assumed. In this scenario, after your renewal you’ll be stuck with an elevated monthly rate due to the increased rates and a need for amortization to be lined up correctly.
A good practice that will chip at your principal is to make mortgage prepayments or accelerated bi-weekly payments as opposed to monthly. It’s a way to some neutralize the damage these skyrocketing rates on variable-rate mortgages with level payments.
The worries don’t end there for variable-rate mortgage holders with level payments. There’s always a chance (albeit unlikely) that interest rates rise at an uncontrollable pace and your payments won’t even be enough to afford the interest owing on your mortgage. Lenders then will increase payments to ensure the interest is covered.
Variable-rate mortgages can be tricky, but with the right modifications to your plan at the right time, you can see your way through.
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