One of the most common requests I get when discussing mortgage options with my clients is that they want the shortest amortization they can afford. They want to pay their mortgage off as soon as possible. I get it! And then I hit them with an unexpected recommendation. I tell them to take the longest amortization possible. Sounds contradictory? I’ll explain.
Let’s suppose you qualify and can afford a monthly payment of $3915 for a $500,000 mortgage amortized over 15 years. Should you choose a 15 year amortization? NO WAY!
There are 3 main reasons why…
1 – CHANGE OF FINANCIAL CIRCUMSTANCES OR JOB LOSS
Let’s suppose you run into some tough financial circumstances a year or two down the road. Maybe your spouse lost a job. You need to reduce that monthly payment to $3,000 to make ends meet. Well, guess what? You’re out of luck. You are stuck with that mortgage and a $3915/mth minimum payment. You can refinance your mortgage but you will have to pay legal fees and probably a mortgage penalty to exit this mortgage. That’s assuming you can qualify. Most times, when there is an income problem, it also means there will be a qualifying problem. Not a good place to be.
A better option is to start with a 30 year amortization that comes with a lower minimum payment of $2639/mth. Most mortgage products have the option to increase your payment by 20% or up to $3166/mth. And most mortgages allow for an annual lump sum prepayment of up to 20% of the original principal balance. In this case, $500,000 x 20% = $100,000 per year. Taking full advantage of this privilege means you could pay the mortgage in full in less than 5 years… of course, most of us can’t do this but that option is there.
Pro tip.. Did you know that making a lump sum prepayment at least once a year has the same overall effect as increasing your regular monthly or biweekly payment? The biweekly payment myth is something I covered years ago. Effectively, there is no advantage to increasing your biweekly or monthly payments. If you increased your regular biweekly payment by $100, that’s $2600 a year. If you made a one time annual lump sum prepayment of $2600, instead of increasing your biweekly payment, the outstanding balance at the end of 5 years would be almost identical. Here’s an in depth study I did on this.
2 – A FUTURE PURCHASE OF A VACATION HOME OR A RENTAL PROPERTY
Believe it or not, we can still dream of owning a cottage or vacation home. It’s true.. (And you don’t have to feel guilty about it no matter what you might be hearing in the media)
Maybe this is off the radar for you right now. You never know what the future brings. Let’s say you want to buy a vacation home or a rental property at some point in the future. You’ll probably need another mortgage. If you chose that 15 year amortization instead of the 30 year, you will need to use that higher mortgage payment in your debt servicing qualification. This could spell trouble for your budget and qualifications.
3 – EASIER RENEWAL OPTIONS
Many don’t realize you can shop around for a better mortgage at renewal time. It’s free to change lenders in most cases. And by shopping, you could save several $$thousand. But, if you took that original 15 year amortization, and 5 years later, rates are higher, and you must qualify with that remaining 10 year amortization at higher interest rates, you may not qualify. This has happened many times with my clients, the ones that didn’t take my advice to go with the longer amortization at the start.
CONCLUSION
Mortgages have become way more complex and complicated. Qualifying today is much more difficult than it was 10 years ago. Mortgage financing is part of your financial plan. Don’t have a plan? You had better get one! And you don’t have to be super rich or even wealthy. A plan is a roadmap of where you are and where you want to be and how to get there.. Speak with a mortgage professional. Speak with a Financial Planner. You’ll be glad you did.
Your best interest is my only interest. I reply to all questions and I welcome your comments. Like this article? Share with a friend.
Steve Garganis: 416-224-0114; steve@canadamortgagenews.