This article was reviewed by Jay Brecknell, CFP®.
What do people need to know about mortgages? The internet is full of articles with advice from everybody and anybody, and if you ask around, the advice is always different. Do this, do that, don’t do this, I would never do that, this worked for me, and on and on and on. As financial advisors, we’re here to keep it simple and cut through the noise. We created a list of must-know tips for you to pass along to someone in your life who is feeling overwhelmed by mortgage conversations—and let’s face it, in 2024, that’s a lot of people.
So, let’s make mortgages simple. We’re going to go over need-to-know terms, how your mortgage payment can have “hidden” costs, common mistakes and how to avoid them, and tips for how to manage your mortgage.
We’re going to cover:
- Common mortgage mistakes to avoid
- How to be more efficient with your mortgage repayment
- Basic answers for how mortgages work and what you need to know
- Useful terminology
Your mortgage: common mistakes
Reamortizing your mortgage
There is endless chatter around about how reamortizing your mortgage is a good solution to higher interest rates. Don’t buy into this narrative. If you reamortize, yes, your monthly payment will be slightly less, but by doing so, you’re simply paying more interest and less principal. So if you increase the amortization, you are paying more interest to the bank and less to the principal. You want to do whatever you can to avoid this, so when money is tight, find other ways to save. Get savvy with your groceries, work extra hours, or cancel subscriptions to save a couple of hundred dollars a month.
Stretching yourself too thin
Here’s the thing, owning a home comes with a lot of expenses: planned and unexpected. When you get a mortgage, you never want to lock into a monthly payment or put yourself in a position to just make your payments. What do we always say around here? Expect change! When signing on for a new mortgage or remortgaging, you want to make sure you can make the monthly payments and have enough breathing room for the inevitable changes life will throw your way.
While life is full of unexpected costs, much of our housing repair costs can be planned for. Houses require upkeep—roofs need replacing, hot water tanks and windows need upgrading. Leave room in your monthly budget to save for these expenses so they aren’t surprises and saving for them becomes routine.
Not taking advantage of low interest rates
If you have a low interest rate, take advantage of it and make a lump sum payment while your payment is lower. If you do this, 100% of the additional payment amount goes towards your principal and when you remortgage, the amount you owe will be less resulting in smaller monthly payments. Depending on your mortgage, you may be able to add extra to each payment or make a lump sum payment; find out what your options are and pick what works best for you.
Taking advantage of your lower rate is the smart long-term play that will set yourself up for more manageable payments when the time comes to renew.
Not adjusting your payments to reflect a rise in interest rates
If you expect your interest rate to go up in the near future, try and increase your payment now to what you expect to pay soon. This will cause more to go to the principal now while interest rates are lower and get you used to the higher rates.
If you’re on a variable rate and maintain your payment rate when interest rates increase, then a higher percentage of your payment will go towards the interest and a lower percentage towards the principal. If you’re on a fixed variable rate and don’t increase your payments, the amount you owe on your principle grows.
We understand that it can be difficult to increase your monthly mortgage payments, but we recommend making lifestyle adjustments to accommodate for the increased payment. In the long run, you’ll thank yourself.
Skipping payments
Many mortgage lenders offer clients a free pass to skip a payment once or twice in the lifetime of the mortgage, no questions asked. While some people may have no other option but to take advantage of this offer, we strongly advise against skipping payments. A skipped payment isn’t a waived payment, and you’ll need to pay the bank when you opt to skip a payment.In the long run, you are only giving the bank more money in the form of interest. Before taking this out, look for ways you can reduce your monthly spending to ensure you can make your payments on time and in full.
Ways to be more efficient with your mortgage repayment
With some strategic financial moves, you can be more efficient with your mortgage payments. Paying your mortgage down more efficiently has three primary benefits:
- You get yourself out of debt sooner
- You pay less money in the form of interest to the bank
- You begin to earn equity in your home sooner
There are some restrictions on paying your mortgage off sooner—the banks want to make money after all—but here are two easy-to-implement financial moves for paying off your mortgage:
Lump sum or extra payments payments
Lump sum payments are any payment you make over and above your standard mortgage payment. These payments go directly towards paying off your principal, which over time, can help reduce the length of your amortization period and the amount of interest you pay. Even small extra payments can add up, so don’t discredit the impact of an extra $100 a month. These payments can be particularly beneficial in the first few years of your mortgage, when the bulk of your payment is being put towards interest. There are restrictions and penalties in regards to lump sum payments, so be sure to read your mortgage contract carefully.
A great time to make a lump sum payment is when you renew your mortgage. At this time, there are no restrictions on the amount you can put down, nor any penalties for doing so. If you’ve come into some money, or have money put aside, this is a fantastic way to pay down your mortgage faster.
Whatever you can afford without going into debt in other areas will help your overall financial well-being.
Capitalizing on your payment schedule: accelerated bi-weekly payments
While a monthly payment schedule is a common choice, an accelerated bi-weekly payment schedule is more efficient. When you select accelerated bi-weekly payments, you make an additional two payments per year—for a total of 26 payments annually, compared to 12 monthly payments or 24 semi-monthly payments. Those additional two payments help pay off the principal faster, effectively reducing your amortization period.
Accelerated Bi-weekly Payments Versus Bi-weekly Payments
Wondering what the difference between accelerated bi-weekly payments and bi-weekly payments are? If you paid accelerated bi-weekly for the entire mortgage, you would pay off your 25-year mortgage 3.5 years sooner. Let’s break it down.
For this example, say your monthly mortgage payment is $3,469.16/month and you want to align your mortgage payments with your pay cycle and make 26 payments a year. Do not choose bi-weekly payments.
Some banks have introduced bi-weekly payments that are $3,469.16 x 12 divided by 26 = $1,601.15. In this case, it is not lowering your amortization as no extra is being paid.
True bi-weekly payments, now called accelerated bi-weekly, is $3,469.16 divided by 2 = $1,734.58 and then paying every two weeks.
The principle behind bi-weekly is that you are making two extra payments per year which in turn go against principal only.
The ins and outs of mortgages
Just because you qualify for a certain amount or a larger loan, doesn’t mean you can actually afford the home you’re about to (or have already) made an offer on. There are a ton of unforeseen costs people are faced with if they don’t have enough money saved.
For example, you may qualify for a mortgage where your monthly mortgage payment is $4,000.00 per month, but if your down payment is less than 20% of the cost of your home, you have to add mortgage loan insurance on top of that. And, in addition, most banks won’t give you the option to pay your property taxes annually if you’re in this situation, so it also gets added to your monthly payment. So already you can see how quickly a doable number can change, and this isn’t even factoring in the maintenance of your home. If you’re still in the savings phase, opening an FSHA account will help you save money for a down payment tax-free, and can be used in addition to your RRSP through the Home Buyers’ Plan.
Qualifying for a mortgage
This applies to first-time buyers, veteran homeowners, and business owners. In the excitement and panic of making an offer, waiting to hear, and scramble to get the paperwork done, people often forget a very important part of the puzzle: qualifying for a mortgage. All too often, people throw out numbers, making offers and telling themselves they’ll find the money somewhere. Not only does this make it harder and sometimes impossible for you to qualify for a mortgage (which is also why so many offers are subject to financing), it will put you in a poor financial position if you do get the house and mortgage. Also, it’s important to note that a huge stumbling block for homeowners and business owners alike (especially depending on how they’re being paid) is thinking they can get a much higher mortgage when in reality, if you or you and your partner are earning $100,000 a year, you’ll qualify for around $400,000. Talk to a mortgage broker about what you can afford, and make sure you’re not only considering the monthly mortgage payment.
Interest rates, amortization periods, and mortgage terms.
When you work with a mortgage broker or bank, you’re given the option to choose between fixed and variable rates, mortgage term lengths, and the overall length of your amortization period. Each of these decisions will have an impact on your mortgage payments and how much money your home ultimately costs you between the interest paid and the principal of your loan. Every person’s situation will be different, so we advise talking to a financial advisor to determine what options are best suited for your financial situation and long-term goals.
Terminology
Amortization
This is the total length of time agreed upon between you and your mortgage broker or bank for repaying the loan used to purchase your home. Typically, this period is around 25 years, but it can extend up to 30 years.
Mortgage term
Your mortgage term is the length of the contract you sign with your lender, usually lasting between one and ten years, with five years being the most common. When the term ends, you renew for another term until your mortgage is fully paid off.
Blended payment
Your mortgage debt has two parts: the principal, which is the amount you borrowed, and the interest. Your monthly payment, known as a blended payment, covers both the principal and the interest. It’s important to know that in the early years of your mortgage, a larger portion of your payment goes towards interest rather than the principal.
Payment frequency
When you sign your mortgage contract or renew it, you can choose how often to make payments. Options include monthly, semi-monthly, biweekly, accelerated biweekly, and weekly payments. Most people choose monthly payments, but we recommend an accelerated biweekly payment schedule.
Lump sum payment
This refers to any additional payments you make towards your mortgage beyond your regularly required payments.
Let’s recap
Mortgage talk can be complex—there’s often a lot of emotion and uncertainty involved but if you keep it simple, you can approach your mortgage with an informed lens and set yourself up for future success. While it can feel overwhelming at times–especially with the rising costs of living—paying off your mortgage can be straightforward if you keep it simple and avoid common mistakes. Remember to:
- take advantage of lower interest rates to make larger payments
- increase your payment to match any increase in interest rates
- avoid stretching yourself too thin financially and purchase a home within your means
- never skip a payment
Otherwise, if you make your mortgage payments on time and in full every month, you’ll be just fine. That being said, there are a couple things you can do that are a little more financially savvy:
- opt for bi-weekly payments
- make additional lump-sum payments throughout your mortgage term
- make a larger lump sum payment at the time of your mortgage renewal
By following these tips, you’ll be better equipped to manage your mortgage effectively and secure your financial future.