New 40 Year Mortgages
Good Or Bad?
By Larry Lloyd
Financial institutions in Canada are now offering mortgages with a payback term as long as 40 years. With the steady rise in house prices in booming markets such as Toronto and Vancouver, it was inevitable. These longer mortgages are meant to help buyers get into the real estate market by lowering their payments by spreading them over a longer period. But is it a good idea?
A longer mortgage gives potential buyers some flexibility in terms of what they can afford to buy. But this affordability comes at a price. The total interest cost of a mortgage that is paid back over 40 years is almost double that of a 25 year mortgage. This is a reality that most first-time buyers don’t understand. People just want the lowest payment possible but in the long run, your house could cost you almost double if you use a 40 year mortgage.
Shopping for a mortgage, and how quickly it can be paid back is as important as shopping for a house or condo. Features such as the opportunity to pay down a portion of the principal once a year or to make double payments will help you pay down your mortgage faster. It is important to remember that during the first five years of a mortgage, three-quarters of your payments go to interest. Any cash you can put down will save you money in the long run.
If a 40 year amortization is the best you can do, make sure it is a short-term mortgage. It can be a reasonable strategy when you are young, but you don’t want to stay in it as the long costs will be quite high. Buyers opting for a 40 year mortgage should renegotiate to shrink the amortization period within a few years.
Here is an example to illustrate this point. To demonstrate let’s use a mortgage of $350,000 with a five year interest rate of 6.45%.
With a 40 year amortization, the weekly payment would be $465 and the total interest cost $597,000. This means that the total cost of buying your house is close to $1 million. With a 25 year amortization, the weekly payment would be $596 but the total interest falls to $265,000. With a 15 year mortgage, the weekly payment would be $698 but the total interest cost would be $191,000.
It pays to reimburse your mortgage as quickly as possible. Sure, a 40 year mortgage will cost you $73 less per week than a 25 year one, but it will cost an extra $254,000 in interest. A 25 year mortgage will leave an extra $102 in your pocket compared to a 15 year mortgage, but it will cost $74,000 more in interest.
Finding a balance between affordability of the payments and the overall interest cost, in other words between your short- and long-term goals, is key. The purpose of a mortgage is to pay off your house and not to live in debt. Remember, a higher down payment when you purchase your house or more aggressive weekly (or monthly) payments could save you tens of thousands of dollars in the long run.
About the Author: Larry Lloyd is real estate specialist focusing on the Durham Real Estate market. Feel free to contact Larry with any questions regarding the Oshawa real estate market or to search for available properties.