New stress test in place for borrowers as of January 1, 2018
- If you already have a mortgage and renew with your current lender, you won’t be asked to pass the stress test.
- If you decide to shop around and switch lenders, you will have to pass the stress test.
Your actual payment is not impacted, but the stress test requires that you qualify for your mortgage based on the greater of:
- the financial institution’s contract mortgage rate plus 2 percentage points
- the Bank of Canada’s posted 5-year benchmark rate
One of the most confusing aspects of buying a home is choosing the mortgage term. While mortgages are usually amortized over a long period of time, they’re also broken down into smaller terms. These terms can be as short as six months or as long as thirty years. Five years is a common term chosen by mortgage borrowers.
The basic difference between long- and short-term renewal periods is the interest rate that the bank charges. Most mortgages are based on the "prime rate", which is the rate the bank charges their "best clients". This rate fluctuates with changes in the "bank rate", which is the rate the banks are charged when they borrow money from the government, a rate that fluctuates with economic circumstances.
Usually, the longer the term, the higher the interest rate will be above the prime rate. For example, if today's prime rate is 3%, the bank may set their mortgage rates for five-year terms at 4.5%. Be aware that the banks are not likely to increase or decrease their lending rates based on the prime rate. There are other factors involved and often, their lending rates will change even if the prime rate has not changed.
At the same time, the rate for a one-year term mortgage may be set below prime. Saving 2% in interest on a $200,000 mortgage is $4,000 a year. The difference is that the rate is only set for one year. If the prime rate increases by 1% over that year, the interest and mortgage payments increase but will still be lower than those for the five-year term. However, if the prime rate increases substantially and stays higher, the five-year term would be the better deal.
Historically, short-term mortgages have been more cost effective over longer-term mortgage amortization periods (that is, five- and, especially, ten-year terms). However, a shorter term does not provide the comfort of knowing exactly what your mortgage payment will be for the next five years. In times of low interest rates, it may be wise to lock in a low rate for five years. Consult with a mortgage specialist or financial advisor before choosing a mortgage term.
In addition to the term, you also need to choose between a fixed interest rate or a variable interest rate for the duration of your term. These terms are differentiated as follows:
The added security of fixed-rate mortgages comes at a cost. Given the same term, interest rates on a fixed-rate mortgage will be higher compared to the interest rate on a variable-rate mortgage.
Be aware that the government has recently adjusted the rules for government-backed insured mortgages. It’s now required that all borrowers meet the standards for a five-year fixed-rate mortgage, even if they choose a mortgage with a lower interest rate and shorter term. This measure is intended to protect Canadians by providing them with additional flexibility to support mortgage payments at higher interest rates in the future.
The mortgage renewal period can often give you a second chance at saving money on your mortgage. There has been a tremendous increase in competition for mortgages among Canadian lenders, which means that if you want a better deal on your mortgage, you’ll likely find one. Shopping around can save you thousands of dollars over the course of a mortgage. This money saved can be allocated to your other financial goals.
There are two types of mortgages: open and closed. These have different allowances for additional payment and payment frequency. Know which type of mortgage you have, as it may affect your ability to make pay down your mortgage ahead of schedule.
Open mortgages accept additional payments at any time with no penalty.
Closed mortgages enforce strict repayment schedules and may penalize or forbid additional payments (the longer you owe them money, the more interest they collect). However, closed mortgages do offer opportunities for extra payments.
Once per year, you may be allowed to either prepay a certain percentage of the outstanding balance or double your monthly payment. For example, making one double payment per year on a $150,000 mortgage with an interest rate of 4.5% will save $15,251 and the mortgage will be paid off three years earlier, based on a 25-year amortization. There is also an opportunity to pay off the entire amount owing on the home, if you can, at the time of the mortgage term renewal.
Mortgage payments may be made monthly, semi-monthly, bi-weekly or weekly and can be timed to coincide with paycheques. Pay earlier and regularly to save on interest over the course of the mortgage. If your monthly payment is $1,500 and you choose a bi-weekly payment of $750, you’ll be making 26 payments of $750 ($19,500) rather than 12 payments of $1,500 ($18,000). Seek the advice of a financial advisor before choosing mortgage terms and payment frequency.