There’s been a lot of changes happening in the Canadian lending scene this past year. With a stricter qualification process and the slow climb of interests rates, those looking to buy their first home are adjusting their budgets all too often. For those of you who got into the real estate market before all these changes came about, you may want to consider increasing your mortgage payments ahead of your mortgage renewal.
WHAT’S CHANGED: CANADA’S STRESS TEST & INTEREST RATES
This year the Canadian government implemented their new mortgage qualification guidelines known as the Stress Test. Under these new guidelines, homebuyers must qualify for a mortgage at a rate of 5.34% or 2% higher than the negotiated rate (whichever is higher).
For those of you who managed to get into the market before the stress test was implemented, congrats! However, when the time comes to renew your mortgage, you, too, will need to pass the stress test.
In addition to stricter lending rules overall, the interest rates have also been climbing. The Bank of Canada’s prime rate has increased 1% since June 2017, having more or less held at 3% for 4 years (late 2010 to 2014) before dropping to 2.85% in February 2015.
With prime currently sitting at 3.70%, the interest rates you’ll be faced with when your mortgage renewal comes around will likely be higher than where you’re currently sitting. In anticipation of the higher interest rates, paying off your mortgage faster by increasing your monthly payments may be a worth-while move.
WHY YOU SHOULD PAY OFF YOUR MORTGAGE FASTER
Why you should consider increasing your monthly mortgage payments is two-fold:
- Increasing your payments will ensure you’ll be able to handle the higher interest rates at the end of your term.
- Increasing your payments will pay off your mortgage faster and reduce your mortgage balance when you go to renew at the higher interest rates.
If your current interest rate is 2.49%, talk to your mortgage broker about adjusting your monthly payments to be more in line with today’s going interest rates. For example, since the prime rate has gone up 1%, see if you can afford the difference each month.
SHOW ME THE MATH
Let’s say you bought a home in 2016 for $600,000 and have been paying your $480,000 mortgage ($600K – 20% down payment) at a rate of 2.49% with an amortization period of 25 years.
The table on the right shows how much you’ll have paid if you were to increase your monthly payments as if your interest rate was 3.49%. Because your mortgage rate remains at 2.49% until the end of your term, this means you’re paying more towards your principal and less on interest.
Similarly, by increasing your monthly payments, you’re paying off your mortgage faster and reducing your mortgage balance when it comes time to renew. So rather than paying a higher interest rate on $351,120, you’ll be paying the higher interest on a total of $342,264.
TALK TO YOUR MORTGAGE BROKER
Work out a budget and see how much of a payment increase you can manage. The reason being is that most mortgage lenders won’t allow you to lower your payments until the end of your term.
If you have the means to increase your mortgage payments ahead of your mortgage renewal, it’s important to ensure you’re within your prepayment privileges. Your mortgage contract will have a maximum percentage increase you can make without paying a mortgage penalty.
Hopefully, the Bank of Canada will refrain from increasing the prime rate for a third time this year. But as a means of preparing for your mortgage renewal, see if you can afford to increase your monthly payments — even a small amount can go a long way. Paying off your mortgage faster while at your current interest rate will pay down your principal and save you money down the line.