As more homeowners prepare for the mortgage renewal process, many Canadians are left feeling anxious about managing their current expenses, debts, and the expected increase in payments.
A recent study conducted by the Angus Reid Institute found that 30% of Canadians are already having difficulty with their mortgage payments. When asked about how they feel about rising interest rates ahead of their next renewal, 77% of respondents said they are worried or very worried about this increase. Rising interest rates are creating extra financial strain, leading 20% of people to dip into savings to account for increased payments.
If you’re worried, you’re not alone. In this blog post, we’ve outlined strategies and tips to help homeowners prepare their finances and navigate the challenges of increased mortgage payments.
Understanding Your Mortgage
Having a clear understanding of your monthly mortgage commitments can help you manage your budget to pay off debt while contributing to fixed monthly expenses. Let’s explore the details of what a mortgage payment entails.
Your payment structure will vary depending on whether you have a fixed or variable rate mortgage, but most have a term length, or the length of time before your contract is up for renewal, of three to five years. This is different from the amortization length, which is the total lifespan of your mortgage. In Canada, it’s common to have a five year mortgage term with a 25 year mortgage amortization period. With a fixed-rate mortgage, your payments and interest rate will remain stable throughout the term of your mortgage, while variable-rates provide room for fluctuation with payments.
Interest Rates
The interest rate on a mortgage is the amount of money that is charged in exchange for a loan. Interest is often expressed as a percentage of the “principal” (i.e., the amount of money borrowed) in the loan and is added to the balance at set intervals. Interest rates for a mortgage can vary depending on the type of mortgage and the current prime lending rate.
What’s the difference between fixed-rate and variable-rate mortgages? A fixed-rate mortgage starts at a set percentage and remains the same regardless of changes in the market over time.
Meanwhile, a variable interest rate will change with the prime lending rate. So, if the prime lending rate goes up, the interest on a variable mortgage will increase. But if the prime lending rate goes down, then your interest rate will also decrease. This introduces some unpredictability but with the potential benefit of having a lower overall interest rate over the duration of the mortgage.
There are two types of variable mortgages. The first is known as an adjustable rate mortgage (ARM). This is when both your payment and interest cost vary as the prime rate fluctuates.
A second type of variable-rate mortgage is a fixed-payment variable rate. According to the Bank of Canada, about 75% of variable-rate mortgages have fixed payments. This is where the payment amount is determined at the beginning of the contract and remains fixed for the length of the loan period. While the total payment amount stays the same over time, the interest changes depending on the prime rate and the remaining sum is put toward the principal portion.
If you expect interest rates to decrease in the future, then a variable-rate mortgage may be a good choice. When you go to renew your mortgage, it may be possible to renegotiate your interest rate and switch from a fixed-rate mortgage to a variable-rate one (or vice versa).
Equity
The purpose of mortgage payments is to bring you closer to acquiring full ownership of your home, known as equity. This is the difference between how much your property is worth and how much money you still owe to your lender through regular mortgage payments.
Each time you make a mortgage payment, this money goes toward interest payments and paying down the principal, or the value of your home, to gain a little bit more equity. When you build more equity, and thus improve your debt-to-equity ratio, the lender will view you as a borrower with a lower level of risk. As a lower-risk borrower, you may be offered a more competitive mortgage rate when you’re up for renewal compared to new homeowners.
Frequency of Payments
Depending on how often you make payments toward paying down your mortgage, you could be paying less overall in the long run. With more frequent payments, you’ll be saving money on interest while working toward paying off your mortgage at an increased rate.
Monthly, weekly, biweekly, and accelerated payment plans can impact your budget. If your lender suggests a biweekly plan, this may be beneficial because you can save money on interest and accumulate more equity over a shorter period of time compared to longer term plans. The accelerated option means you pay more annually than a standard biweekly payment plan.
To put it simply, biweekly payment plans include multiplying your monthly mortgage payment by 12, then dividing it by 26 pay periods in the year. On the other hand, accelerated biweekly payment plans simply divide your current monthly mortgage payment by two. Both plans include 26 payments per year, but the accelerated option includes an amount that is slightly higher.
For example, as outlined by Ratehub.ca, if your monthly payment is $1,295 and you opt for an accelerated biweekly payment plan, this splits the monthly sum into two payments of $647.50 biweekly. Over the course of the mortgage, you will pay more annually to your lender (as compared to the regular biweekly). That payment can save thousands of dollars in interest as you pay extra on your principal and reduce the amortization period by a few years.
However, bi-weekly payments increase frequency, which can impact your ability to pay down other financial obligations, such as contributing to debt repayments. To learn more about frequency of payments and how to stay on a fast track to home equity, speak with your lender.
4 Tips to Manage Your Debt When Preparing to Renew Your Mortgage
Here are some tips to help you stay on top of your debt while preparing for your mortgage renewal.
1. Calculate the Impact of Reducing Your Mortgage Term Before Renewal
Typically, lenders send a renewal letter within the final 30 days before your current mortgage term expires, and that letter will include interest rate information if you choose to renew with that same lender. However, most lenders in Canada allow you to renew your mortgage term anywhere from 120 to 180 days before your current term expires.
As you approach your renewal, consider your options for the length of your next term. As noted, within at least six months of your current term ending, you can explore options to find better interest rates for shorter terms. For example, if you’re on a five-year term, you might be able to lock in a good rate for a three-year period, and when that term comes to a close, interest rates could be even lower.
It can be difficult to project how these rates will change over the course of a few years, but a short term might give you some flexibility in the future. For example, a lender might offer a five-year fixed rate mortgage at 6%, but a three-year rate may be lower, such as 5%. The risk with a shorter term is that the market may not be lower when it’s time to renew again.
Interest rates frequently change, so speaking with a professional can ensure that you have precise information about current rates.
2. Consider a New Lender
Different lenders might offer you different rates. So, it’s important to keep in mind that you don’t need to stay with your current lender if their mortgage rates don’t meet your needs. This is why it’s important to discuss your current rates with your lender before the mortgage renewal process.
Begin by researching what other lenders have to offer. This can give you an upper hand when it comes time to negotiate with your current lender. You might even be able to negotiate a lower rate this time around so you’ll be paying less than you were previously. Lenders want to keep your business, so it’s very possible to negotiate a better deal this time around.
Speaking with a mortgage broker 90 to 120 days before your renewal may provide more options than working directly with your financial institution. This is the length of time that a broker can typically secure a rate for you. A broker will also help you keep track of multiple lenders, prepayments, and penalties, and even provide you with quotes without you needing to directly contact various banks.
3. Be Proactive in Researching Rates and Adjusting Your Budget
Ahead of your mortgage renewal date, begin the research mentioned above. The more time you allow yourself to ‘shop around’, the more likely it is that you’ll be able to get the best rate.
Additionally, adjusting your budget before your increased payments begin will provide an opportunity to get used to changes in your spending. It can also provide the opportunity to add to your savings in preparation for increased payments.
Use tools like a budget planner and expense tracker to set realistic spending guidelines for all of your expenses. This information will help you see your monthly expenses in a comprehensive view, and it will guide your habits to ensure that you stay within your budget for each spending category. You will likely find that it’s worthwhile to cut back on variable expenses, such as eating at restaurants, in order to prioritize your fixed expenses, like debt and housing.
Simply put, using a budget planner can help you prepare for the potential increase in mortgage payments before you renew so that any necessary lifestyle adjustments will be more manageable.
4. Consider Rolling Unsecured Debt Into Your Mortgage
One thing that some Canadians choose to do to help manage their debt is to consolidate their unsecured debts (like credit card balances) into their mortgage. The potential advantage of this is that, since mortgages may have lower interest rates than many other forms of debt, this helps reduce the amount of money you will have to pay in the long run.
This strategy leverages the equity you have in your home. For example, if your home is worth $800K and you owe $600K on the mortgage, then you would have $200K of equity. If the home increases in value, then your equity will also increase.
Rolling other debt into your mortgage is sometimes called a “debt consolidation mortgage.”
Before doing this, it’s important to consider a few important factors:
- Incremental Costs: Consolidating debt into your mortgage may incur costs like a home appraisal for $300 or more, or legal costs of $800 to $900 in some cases.
- Your Current Credit Score: If you want to roll your other debts into your mortgage for a potentially lower interest rate, you’ll need to qualify for a new mortgage. This may mean having the lender review your income, and credit score, and passing the mortgage stress test to determine your eligibility for the new loan terms.
- The Current Value of Your Home: The current value of your home is very important for determining your equity and how much of your other debts you can roll into your mortgage. The more equity you have, the more comfortably you can roll your debts into it. Keep in mind that you need to have at least 20% equity in your home in order to qualify for a refinance. If you have less than 20% equity, you will need to wait until either your home value increases or you pay down your mortgage further before starting the refinancing process.
When applying for a consolidation mortgage, it’s important to avoid racking up more debt. It’s easy to start spending more once credit card balances have been cleared—which can actually lead to an increase in overall debt.
To avoid this, it can help to cut up the credit cards once the debt has been transferred into the mortgage or take other measures. It can be helpful to speak with a non-profit credit counsellor from Credit Canada to ensure that you are taking steps to maintain a good credit history and avoiding any negative impacts to your credit score.
Prioritize Repayment of Debt
When preparing for an anticipated increase in your mortgage payments, consider how it will impact your current debt. There are tools and resources available to help you figure out how increased mortgage payments will impact your other expenses, such as debt calculators, and budget calculators.
To balance debt and mortgage payments, you’ll need to be able to pay at least the minimum amount on your monthly statements. If not, you run the risk of damaging your credit score–which can impact the mortgage rates offered by lenders. Making these minimum payment amounts can take less money out of your pocket, but it will extend the amount of time needed to become debt free.
As previously mentioned, a good option for helping you repay your debt is to consider consolidating existing debt into your mortgage when you start the renewal process. However, debt consolidation is a complicated topic, so it’s important to consider all the factors before renewing with a debt consolidation mortgage.
For example, if you qualify for a debt consolidation mortgage, you want to ensure that the interest rate makes sense upon renewal. If your new rate is higher with the added debts, you want to confirm that the lower rate on the non-mortgage debts outweigh the higher rate on your mortgage over the course of the new mortgage terms.
Ultimately, prioritizing debt payments and mortgage payments will take some restructuring of your budget. Becoming debt free doesn’t happen instantaneously, but Credit Canada is a trusted resource to help make the journey a bit easier.
Seek Advice From a Financial Expert
Credit Canada is here as an additional resource to help you get out of debt and prepare for your next steps as a homeowner. With our certified credit counsellors and financial coaches, you’ll meet a team of experts that are ready to help you pay off your debt. We understand that figuring out your debt and your mortgage payments at the same time can be challenging, but we have a variety of resources to help you take control and manage your finances. Reach out to us today to learn more!
