It used to be that choosing a mortgage was much like choosing what color of Model T Ford to buy. They were all pretty much the same: black, or black. Today, the marketing gurus have been working overtime at all the banks to give consumers a myriad of mortgage options. These options are great, but they tend to muddy the waters.
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One of the best pieces of advice I learned in university was the KISS principle ("keep it simple, stupid"). This principle works in almost every facet of life, including mortgages. If you weed through all the marketing gimmicks and stick with the basic options you need in a mortgage, you will save yourself a lot of grief.
The most important issue with any mortgage is the cost. Your goal is to minimize your cost so you should be very conscious of interest rates and how they are calculated. Don't be enticed by low introductory rates; these are usually gimmicks. You need to look at your effective rate over the full term of your mortgage. Most mortgages have their interest calculated semi-annually but there are several new products on the market that compound their interest monthly. The more often a mortgage rate is compounded the higher your effective rate is; semi-annually is good, monthly is bad.
The term of your mortgage is important. The term you choose will usually dictate how long your interest rate is guaranteed for. Typically, the yield curve for mortgage rates slants upwards and to the right, meaning that the longer your term the higher your interest rate. Choosing a long term mortgage is a form of insurance. You are guaranteed that your interest rate and payment amount will not change for the term you choose. Whether you need this type of insurance is dependent on your personal financial situation. Do you have a good cash flow? Can you afford to pay an extra few hundred dollars a month if your interest rate goes up? There is no right answer but you want to be darn sure you don't roll the dice and end up losing your family's home!
A variable rate mortgage has been the hottest product over the last little while. With interest rates dropping steadily over the last few years, a lot of consumers saved a bundle by choosing a variable rate. Most variable rate mortgages base their rates on the bank's prime rate. When the prime rate goes up, your rate goes up; when the prime rate goes down, your rate goes down. There are no standard terms and conditions with a variable rate mortgage. Every lender has put their own twist on their own variable rate mortgage. (The marketing guys have worked overtime on these products.) Remember to cut through the fluff and look at the bottom line when comparing variable rate mortgages. What is your effective interest rate over the entire term, not just the introductory period? Remember that these mortgages may have a long term (e.g. 5 years) but your interest rate is not guaranteed. If you are the type of person who is conservative or has a tight cash flow, this is not the product for you, especially in our current rate environment.
Flexibility is the other variable to look at. How flexible is the mortgage? Can you pay weekly, bi-weekly or monthly? Can you make extra payments at any time or just once a year? Is your mortgage convertible to a longer term? What rate will they give you, the posted rate or a discounted rate?
Having a mortgage that is flexible is nice, but the most important factor is cost. You need to look at the effective interest rate of the mortgage over the term you choose. If you keep things simple you will choose the right mortgage every time!
Andy MacDonald (BA Econ.) is president of MortgageBroker Inc. He has more than two decades of financial services experience and has long been an advocate for consumers within the mortgage industry. Visit his Web site at MortgagesInCanada.com.
