With so many mortgages available on the market today, it’s important to realize the importance of comparing the different types of loans. But how do you know the best way to compare? And what are the most important features?
Most home buyers focus on the interest rate of any potential loan. After all, the interest rate is what determines the final price that you’ll pay on top of the loan itself. For obvious reasons, a loan at 2.9 per cent is much more attractive than a loan at 3.4 per cent, all else being equal. But therein lies the rub: all else usually isn’t equal when it comes to mortgages.
James Harrison, president and founder of Mortgages.ca, suggests that home buyers looking for a mortgage go to their bank first, then ask around for a recommendation for a very experienced and successful mortgage broker.
“The broker will be looking out for the client’s best interest not the bank,” Harrison says, “and they should go over all of the terms and conditions of each mortgage option. It is not all about rate that is for sure.”
What to compare
Mortgages vary in many ways, including the length of the term, whether they’re open or closed, the length of the amortization period, and yes, the interest rate. The interest rate is a point of comparison all its own, but it can also give you an indication as to why particular mortgages are priced the way they are.
Let’s say you can afford a $300,000 mortgage. What are the benefits of choosing a five-year term over a one-year term? A one-year term almost certainly has a lower interest rate, but that means that you have to renew your mortgage in a year’s time. That may be good for you if you expect your financial situation to improve, or it may not be worth the hassle to get you an interest rate that’s .2 per cent lower than the five-year rate. (Remember, every time you renew your mortgage at the end of a term, you have the option to change lenders. If you change lenders, you’re basically applying for a new mortgage, which means submitting all of the documents and meeting all of their mortgage requirements.)
A good rule of thumb to keep in mind is that the lower the interest rate, the more “no frills” the mortgage is. If you want more stability and flexibility, the interest rate is generally higher.
Apples to apples
Make sure, however, that when you’re comparing mortgages that you’re comparing apples to apples. If you know you want a variable rate mortgage, then compare variable rate mortgages with different lenders. If having the option to pay off the mortgage before the set amortization period is important to you, then having an open mortgage is a priority. While comparing open mortgages to closed mortgages may be useful in terms of figuring out what your priorities are, once those priorities are set, you want to be able to make accurate comparisons between lenders, which means that you want to compare products that are as similar as possible.
Something else to consider is that it isn’t necessarily a cut-and-dry decision. Maybe what looks for your wallet doesn’t give you enough flexibility in your short-term future, or vice versa; maybe you want to play it safe and avoid any surprises down the line; maybe you want to do what’s best for you right now because you’ve weighed the options and the benefits of saving money in the short term beats the risk of foregoing stability. There’s no right or wrong answer.
When you’re getting a mortgage, nothing else could seem more important to you than what’s happening here and now, whether that be your employment situation, the ups or downs of your housing market, and the short window of time that your mortgage preapproval will be honoured. But you should make an effort to get a mortgage that fits you now as well as years down the road. When talking to your mortgage broker, make sure you talk through your life plans and financial plans for the future. Unforeseen circumstances may arise, but at least your broker will be able to get you the best mortgage for your needs, as opposed to just getting the lowest rate.
In order to compare mortgages, you need to have a number of options to choose from, which is where your mortgage broker can be very useful. Your mortgage broker is the best person to talk through various scenarios with you for each mortgage, and an experienced broker will bring up situations that may not have occurred to you before. It may also help to put the details of the mortgages that you are considering into a spreadsheet so you can see everything side by side and understand everything that you need.
Comparing different kinds of penalties
The big penalty that’s often discussed is the interest rate differential (IRD), which is what you pay when you break your mortgage before the end of the term. But there are also penalties for paying a certain amount more than your set mortgage payment or making a larger-than-allowed extra payment. This may seem to go against conventional wisdom (isn’t paying off your mortgage a good thing?), but remember, your lender is making a certain amount of money off of you and your mortgage, and they’ve counted on that money for the length of your mortgage term. So if you suddenly start paying off your mortgage faster than they anticipated, that shortens the length of time it takes for you to pay off your mortgage – and the less time it takes, the less money that your lender is going to get overall because you’re going to pay less in interest.
If you are expecting an inheritance, for example, and want to put a large portion of it toward your mortgage, you can be limited by the restrictions on lump payments (usually the limit ranges from 10-30 per cent). If you expect raises and bonuses from your job on a regular basis, and you want to be able to increase your mortgage payments over time, you want to be able to do that without penalties. You may not be planning on moving, but you might want to tap into your home equity for renovations, which counts as breaking your mortgage and comes with penalties as well. These penalties could all have a huge impact on the overall cost of your mortgage, so it’s worth walking through all of the options with your broker and making sure that they understand any life changes that you anticipate.
Put all your cards on the table
You can’t do an accurate mortgage comparison if prospective lenders don’t have all of the information. It’s not enough to look at the advertised rates of different lenders online, and then think that those are the rate, terms, and conditions that apply to you. That’s a good start, and a good way to educate yourself, but isn’t going to provide you with the most accurate picture. Your credit rating and history matters, your down payment matters, and anything else that you may not be telling your lender can have an effect on the rate that you’re offered for your mortgage.
A good mortgage isn’t a good mortgage in every situation, and a good mortgage may mean something different if you’re buying a single family home versus a vacation home versus an investment property. When comparing mortgages, keep in mind your goals and finish line, and choose one that aligns with both.
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