How to avoid mortgage payment shock

Every year this week befalls many unprepared for the big day that is upon us. Similarly, the same holds true for those that review their financial plans and in my business an annual mortgage checkup.

Mortgage interest rates have been exceedingly low since the beginning of 2009, which was due to the economic crash in September 2008. To keep the economy humming, governments around the world have kept money extremely cheap creating an environment for those that have entered the housing market ill-prepared for the changes that are coming – the inevitable rise of interest rates.

It’s strangely odd that even at the interest rate pricing today, many don’t understand how low these interest rates are, especially first-time buyers. This has been a Christmas gift from the government coffers from Christmas past and it keeps on giving.

But what the first time buyers’ parents know is that it’s going to eventually end, but that young naiveté still seems to creep in like the good times are going to keep on keeping on.

I recently had a young couple in their early 20s and like many young couples in Red Deer she works in an office and has a two-year diploma whereas her fiancé works in the oil field. They are both very understanding of frugality, live within their means and they’ve saved up their down payment and closing costs in a little over a year.

They recently purchased a house for $294,000 and their payment is going to be $1,269/month based on a 3.39% rate and a 30-year amortization.

Every one of my clients is provided with a mortgage education. I explain where the interest rate market has been to where we are today and where the mortgage interest market is going.

That last part is the most important as interest rates will be much higher thus increasing the mortgage payment upon renewal. The looks I get when I explain their next payment is the same with everyone — it’s one of shock. The interest rate I use to explain the next payment is based on the 20-year average discounted interest rate which is 5.85%. The last time we had those high of interest rates was not so long ago, it was immediately after the September crisis of 2008.

To eliminate what we call payment shock, one has to be prepared for it. The next step is to create a five-year mortgage plan, and find out how much you are going to owe at the end of the five years. In the above example, they will owe $257,317 at the end of their fifth year and that’s if they don’t take advantage of any pre-payment privileges.

We input the end of term mortgage value of $257,317 and enter the 20-year average rate of 5.85% and this is the part where I get all the glances. Their renewal payment will be $1,623.46, based on a 25-year amortization. Questions like, “How does my payment go up after I paid it down over $35,000?” and statements like “Your math or calculator is wrong!”

Once they’ve settled down and accepted the fact that interest rates are key to mortgage costs, and learning that one has to be prepared to act and take advantage of these times we review the payment shock elimination strategy.

This next part is very simple, but actually has to be done every year so that you can take advantage of the savings and take control of your mortgage.

We take the renewal payment of $1,623, subtract the current payment of $1,269 and we come up with a value of $354.

This is the increase in monthly payment in five years should you do nothing. But the strategy is to take that $354/month and divide it by five (years of your fixed mortgage) and it comes to $70.80.

After your first year, you call your mortgage lender and you increase your monthly payment by $71/month, and on each anniversary date of your mortgage you increase your monthly payment by that $71/month and you’ll be right on target for that next payment on your renewal date.

This has done a couple of things, firstly prepared you not just for today’s payment, but also for the renewal payment and at the same time you’ve actually paid down your mortgage an extra $3408 directly towards the principal and saved you another $3000 in interest, just by having a mortgage strategy.

Your mortgage is one of the biggest costs you’ll likely ever have, why leave it to chance that it’s going to be paid off the way the bank wants you to pay it off? Why not fool the bank and be prepared for it!

Jean-Guy Turcotte is an Accredited Mortgage Professional and can be reached for appointments at 403-343-1125, texted to 403-391-2552 or emailed to jturcotte@regionalmortgage.ca

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