There is an older generational belief that our main goal should be to pay off our mortgage as quickly as possible (and pump as much money into RSPs as we can). We hear this frequently. Many clients feel they should crank down their Amortization periods to pay off their mortgages more quickly.
We disagree and here’s why… Taylor and Christine were referred to us by their neighbours, whom we recently helped when their current big bank couldn’t (or wouldn’t). Taylor and Christine told us that they now realize they have been too aggressive with their mortgage amortization period and RSP contributions over the last 10 years, which has resulted in the accumulation of $60,000 of high-interest consumer debt. This includes a $40,000 secured line of credit (SLOC) against their home (of course with an interest rate higher than their mortgage).
Both sets of parents strong-armed them into thinking mortgage debt is bad debt, and they need to pay it down as quickly as possible. (Their parents also encouraged them to max out their RSP contributions annually to save on income tax… only to be taxed later at current rates at retirement, I might add. I know, I used to do it myself.)
This old-school mentality lead them to sign up for a mortgage with a 15 year Amortization (AM), with their bank, locking them into $2000/month payments. A standard 25 year AM would have had $1200/month payments; leaving them devoid of $800/month in cash flow, money borrowed for only 3%.
Had Taylor and Christine been our clients from day one, we would have looked at their entire cash flow picture, their future goals etc., and advised them differently. You see, banks have a completely different set of goals. They are trained to sell us products with the highest interest rates possible, reeling clients in with mortgages at low interest rates.
Here are the facts. Amortization periods are generally 25 years. They can be extended to 30 years and with some lenders, 35 or even 40. Extending the AM lowers your monthly payments and also enables you to qualify for a bigger mortgage.
There is a more flexible way to pay down your mortgage faster, by taking advantage of your pre-payment privileges. Most of the lenders we work with offer generous pre-payment privileges of up to 20% (contact me for details). Many banks offer only 10%.
By taking advantage of your pre-payment privileges with our lenders, you can cut your AM period down by over 5 years over the course of a 5-year term. The difference? You do it when you can, not because you’re locked into an inflated monthly payment.
By paying down their mortgage too aggressively, Taylor and Christine’s cash flow and ability to save liquid funds for rainy days was crippled. They were told by the bank that their best option was to take out an SLOC, rather than to refinance their mortgage. Since then, they have been paying much more interest to consumer debt products than they’ve been paying on their mortgage, (or earning on their RSPs for that matter).
Finally, they were lead to us by trusted friends and we have changed the course of their financial lives so they can now breathe, enjoy the home they own and most importantly enjoy their lives! Contact me to see how I can help you. ~Written by Jenn Price