Image: bluemodern via flickr
Despite the recession, average home prices have been rising throughout the last decade. In contrast, wages have generally not kept pace with the rising cost of owning a home. The result has been that home buyers, particularly new home buyers, have been choosing longer amortization periods for their mortgage. Traditionally, Canadians have done 25-year amortization periods; however, according to the Canadian Association of Accredited Mortgage Professionals, nearly half now choose a longer period. Are these people making a wise decision?
The problem with choosing a longer amortization period is that in the end, the consumer is paying more interest than they need to. It can also encourages some buyers to enter the market when they can’t necessarily afford it.
The Federal government is concerned about exactly this problem. In 2008, it shortened the maximum amortization period from 40 years to 35 years, and it made it mandatory for buyers to supply 5% of the cost of the home when they were buying. In December, Finance Minister Jim Flaherty made indications that he could possibly further restrict amortization periods to ensure the country does not experience a housing bubble.
“Well, we have to watch and we are watching and monitoring,” Flaherty said. “As you know, we took steps a year or two ago to restrict the amortization period for insured mortgages but we’re watching that. People have to make sure that the mortgages they take out today either have a fixed rate or they know that they’ll be able to handle increases in that mortgage rate later on.”
However, there are benefits to longer amortization periods. Although potentially problematic for consumers who are buying out of their price range, longer amortization periods can be an effective way for wise consumers to invest. With interest rates low, it might be more profitable to sock away some of the money that would have gone to interest payments in high-performing investments.
Another effective way to use a longer amortization period to your advantage is to do accelerated bi-weekly payments instead of payments twice a month. Under this scheme, consumers pay essentially an extra month’s worth of interest payments per year compared to a traditional mortgage payment plan. The benefit to this plan is that it is faster – it can take up to five years off your mortgage. As well, if interest rates rise, consumers can switch back to the twice a month payments, which could negate the increased cost. Mr Benjamin Tal, a senior economist for CIBC World Markets, says nearly 40% of the consumers who choose a longer amortization period choose the accelerated bi-weekly payment plan.
Don’t listen to the critics: depending on your financial situation, a long or short amortization period might be right for you. But, as always, before making any major decisions, consider the ramifications with a qualified financial expert. They can help you assess what you can truly afford. And good luck!
Nelson Goulart
Broker of Record with Signature Service GMAC Real Estate
www.ssgmac.ca
