Mortgage Myths

03 Oct 2009
Mortgage Myths
When I sit with new clients, and I ask them what their thoughts are for mortgages. More often than not, they say that they plan to get a 5 year fixed rate mortgage. At this point there are three key misconceptions or myths I'd like to dispel, as follows:
MYTH 1: The best mortgage term is a 5 year fixed rate CLOSED.
The 5 year fixed rate is one of the most popular mortgages and perhaps three quarters of my clients have this in mind when seeking pre-approval. The trouble with this mortgage is that due to its popularity the rates are quite high relative to the 1 to 4 year terms or variable rates. Another important factor to consider is that if you move and need to close out the mortgage you often will be facing stiff penalties to close out the mortgage. One of my clients had to pay nearly $10,000 to close out her $335,000 principle owning mortgage. You can usually keep the same lender and try to negotiate around the fee, but isn’t being forced to stick to a single lender also a penalty? Note that OPEN mortgages allow wide pre-payment privileges but cost more typically.
MYTH 2: The type is limited to fixed or variable interest rate.
Let’s think of a couple trying to decide between fixed and variable. One prefers fixed rates for the peace of mind, and the other for the low rates, knowing that historically variable has been the cheaper option 88% of the time.  Currently variable can be 1.5% cheaper than available fixed rates. Now if this couple had trouble deciding their course of action, wouldn’t it be great if they could split the mortgage between fixed and variable. Well they can. I know of at least one lender, National Bank, that offers a Diversified Mortgage which allows you to split your principle between fixed AND variable rates. Furthermore, they can tailor the term as well to take advantage of different rates for different terms. Here is an example split three ways.
$100,000  1 year Fixed Rate       2.75%
$100,000  3 year Fixed Rate       3.69%
$100,000  5 year Variable Rate   2.5%
= Average rate of [i][u]2.98%[/u][/i]
MYTH 3: In order to fix my monthly payment a fixed mortgage is required
Some of my clients intend to select a fixed interest rate mortgage because they want the convenience of the same payment monthly.  The misconception is that only fixed rate mortgages offer this-- untrue. With a variable rate mortgage, you are normally free to set the payment to whatever you like provided that it meets the minimum required payment. With variable rates as low as 2.4% and fixed at 4%, a good strategy for a borrower with a variable mortgage is to set the monthly payment as if the interest rate was 4%. 
The difference will go towards the principle of the mortgage and will reduce the interest paid and the number of years to pay off the mortgage. If and when variable rates rise above 4% the savings in interest and smaller remaining principle could still leave you ahead of the game. 
In Summary:
1.       Select a term that is appropriate for your intended length of stay in the home when choosing a CLOSED mortgage.
2.      Choose variable or fixed based on your risk tolerance or comfort level, not on whether you want a fixed payment or not.
3.      Examine blending options such as portion of mortgage in fixed and a portion in variable.
4.      Pay your minimum plus as much as you can afford monthly.
5.      Consult a Mortgage professional to determine all of your options, and shop around.
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