Upward pressure on fixed mortgage rates remains, and if bond yields continue with their upward trend, then fixed rates will continue to rise. The regular readers of my blog will know that fixed mortgage rates are largely influenced by bond yields. When the yields begin to trend upwards, this in turn will place upward pressure on fixed mortgage rates. It’s always important to mention that bond yields do not have any direct impact on variable rate mortgages, just as the Bank of Canada interest rate announcements do not have a direct impact on fixed rates.
Mortgage Rates Will Increase Further
One thing that is almost certain, is that mortgage rates will be higher in five years than they are today. In last week’s blog, I discussed the effect of mortgage rate increases at renewal, where I gave examples on what would happen if the rates doubled or even tripled by the time your mortgage comes up for renewal.
While double the mortgage rate doesn’t mean double the payment (as explained in last week’s blog), the increase in payment is still lot to handle for many.
While you don’t have any control over the direction of mortgage rates, you do have control over how you manage your mortgage. Getting a super low mortgage rate is one thing, but the advice you get along the way from choosing the right mortgage professional can save you far more than a small variance in the rate given when initially setting up your mortgage.
Here’s What You Can Do About It
What I would recommend doing is using your prepayment privileges to increase your payment while your rate is still low. Anything you add over and above your regular scheduled payment will be applied 100% towards your principal. It doesn’t matter which lender you’re with, or what their terms are. The concept applies the same across the board. As your interest is already set, the additional payment can only be applied to the principal.
By increasing your payments now, you’re getting in ahead of the game. This has two major advantages:
- Lower balance at renewal
- You’re eliminating future payment shock
We’ll continue using the same example from last week’s blog to illustrate these advantages:
$500,000 starting mortgage balance
1.89%* 5 year fixed rate
25 year amortization
Monthly payment of $2,090.81
Lowering Your Balance At Renewal
While rate may be higher, it will be on a lower balance. Even if all you do is choose accelerated biweekly as your payment frequency, and pay nothing more, your balance at the end of five years would drop from $417,876.24 to $406,862.63.
That’s $11,013.61 lower than what it would have been if you stuck with monthly payments.
If you take it even further and use your prepayment privileges to increase each accelerated biweekly payment by another 10% for example, then this would drop your ending balance to $392,617.88.
The 10% increase to your accelerated biweekly payment is only $104.54 (total payment of $1,149.95), however you’ve now knocked your ending balance down by an additional $14,244.75 over accelerated biweekly payments alone.
By doing accelerated payments, and increasing by an additional 10%, your ending balance would be $25,258.36 lower than it would have been if you did nothing at all.
That’s $25,258.36 that you will not have to pay interest on in the future.
Like I said, rate might be higher, but it will be on a lower balance.
This sounds doable, doesn’t it?
Eliminating Future Payment Shock
It’s easy to understand that higher rates equal higher payments. By using your prepayment privileges to artificially increase your payments in advance, you’re preparing yourself for higher payments in the future. This in turn eliminates the future payment shock that would come from higher rates. This way, you’re increasing the payment on your own terms, not on the market’s terms.
If rates doubled, and you did nothing at all, then your new monthly payment would be $2,477.66.
If you implemented the strategy mentioned above, and if rates doubled at renewal, your new minimum monthly payment would be only $2,327.90.
While no one wants to pay more in interest, the new payments would be manageable for you. After all, you’d be used to paying $2,491.55** per month on your mortgage (which is the equivalent payment to roughly 3.48% in interest). I’m not saying that this is where the rate will be. No one can predict that. I’m just staying with the example on rates doubling by the end of your term.
This same concept also works well with variable rate mortgages.
Conclusion
Mortgage rates will increase over the next few years. While we don’t like it, it’s not something that we can change. Once you have a better understanding of the impact of higher rates at renewal, it’s not quite as scary as you may have originally thought.
Increasing mortgage rates is not something that we have any control over, so all we can do is prepare for it and be ready for it when it happens.
*1.89% is available for insured mortgages only and is subject to change without notice.
**Accelerated biweekly payment of $1,045.41 + 10% x 26 / 12 = $2,491.55
