As you may have heard, CIBC recently announced that fewer Canadians are in a rush to pay off their mortgages. The reasoning behind this: Record low rates.
Based on the polling results, which surveyed 1,509 randomly selected participants, fewer Canadians are in a rush in pay off their mortgage as stats dropped from 68 per cent last year, to 55 per cent today. The poll also shows that 23 per cent of these Canadians have accelerated their payment frequency (down from 42 percent); 28 per cent increased the payment amount (down from 30 per cent), and 18 per cent made lump sum payments. Overall, the average Canadian is expecting to be 58 by the time they are mortgage free.
While the idea of boosting mortgage payments while rates are low and payments easy to make, still the number of Canadians taking this approach has dropped. Interestingly enough, the same report shows that the number of individuals who are spending their money on renovations has increased by 30 per cent since last year, while vacations have also rose 20 per cent.
With numerous renovation rebate programs available in Canada, it makes sense why more and more people are renovating their homes. As for vacations, who doesn’t love a good getaway, especially in our workaholic society. Still the bank is suggesting otherwise.
“With current low interest rates, this may be an opportune time to make progress against your mortgage- even a few small changes can make a big difference in the length of time it takes to pay off your mortgage and the amount you need to pay in interest charges,” said Barry Gollom, Vice Presidet of secured lending and product policy for CIBC.
That being said, it’s probably not a great idea to go and drop every dime you have into boosting your mortgage payments. Sure, it would seem like you were knocking off a chunk of your overall balance owing, but what are you going to do if you cash out now and interest rates rise? How are you going to make those now higher monthly payments?
With that in mind, let’s weigh the pros and cons of paying more now versus saving the extra cash. Since we know that the average Canadian spends $2,600 a year on vacationing, let’s say that the individuals in this case study are not vacationing and have that additional income to spare.
Karen and Joe each have a mortgage of $350,000 at a 2.99% interest rate, with a five year term and 25 year amortization period. This means monthly mortgage payments for both of them are going to be $1,654.56. What sets the two apart is that while Karen prefers to hold on to her additional cash flow, Joe on the other hand puts everything he has into paying off his mortgage as quickly as possible. At the end of the five year term, Karen’s outstanding mortgage balance will be $299,103 and Joe’s will be $285,296. The difference between Karen’s and Joe’s balances is $13,807, yet of this amount only $807 is interest. The remaining 13,000 (2,600 x 5) is money that Joe personally contributed over the five years to boost payments and ultimately make his mortgage end sooner.
Let’s say the interest rate rises to 4.99%. Based on their current outstanding mortgage amounts, Karen’s new monthly payment amount is going to be $1,963.87 (an increase of $309.31) and Joe’s will be $1,873.21 (an increase of $218.75). Since Karen pocketed her additional $2,600 each year, over the five years she has saved up $13,000. This works out to $216.67 a month that she can then put towards her new monthly mortgage payment, which then means the higher rate is only costing her $92.64 a month.
Karen's Initial Monthly Payment: $1654.56
Karen's New Monthly Payment: $1963.87
The Difference Between Karen's Payments: $309.31
Karen's Savings Over Five Year Term: $216.67
The Difference Once Karen's Savings are Applied to her Payment Due: $92.64
If Karen wanted to keep her payments at the original monthly amount of $1654.56 and use her savings to support her new payment amounts with the higher rate, she would have to increase her amortization period by a year and a half, back up to 21.5 years.
On the other hand, since Joe has been putting his additional $2,600 each year towards mortgage payments, he will not have the funds to make the new payment of $1,873.21; a $218.75 increases from his original payments. In order for Joe to afford his monthly mortgage payments he will have to increase the amortization period back up to 25 years.
At the end of another five year period Karen will owe $254,770.94 and Joe will owe $252,460.02.
Joe’s outstanding balance is lower because he contributed $13,000 more than Karen did in the first five year term. Considering the small difference between their outstanding balances ten years into the mortgage, is it worth paying more now while rates are low, or is it smarter to hold on to your extra cash in case rates suddenly rise?
There are several points to consider when deciding which is the best route for you.
-Are you the kind of person who has a monthly budget in place and would be in trouble if rates rose?
-Will you lose sleep at night knowing you’ve thrown all your money in mortgage payments and if rates rise you’re doomed?
-Do you currently spend extra cash on things like renovations and vacationing that could cover you if need be?
-Do you have additional savings set aside for emergency spending?
-Do you have an all or nothing kind of attitude?
-Do you crave immediate gratification whether it’s a new car, trips, etc.?
-Are you a believer in the, “I’m going to be paying this off for years anyways, so I may as well enjoy myself now,” mentality?
Perhaps the winning solution in this case would be to take the best of both worlds. Why not set aside a portion of your extra cash flow for an unexpected rise in rates, and use the other portion to pay down your mortgage, put some into savings, and take a trip!
As the bank suggests taking advantage of the low rates and paying down your mortgage quicker, this isn’t a bad idea as long as you can support yourself should the situation take a turn. At the end of the day no one wants to be set back into a longer amortization period than anticipated, so it’s important to make sure you’re covered when rates begin to rise.