There are many factors you have to decide on before finalizing your mortgage decision. The key factors are amortization, term of the mortgage, open or closed mortgage, prepayment privilege, interest averaging, interest rate options, payment schedules, assumability, and portability. A brief explanation of the first four items was discussed in the last column, Part I. This column, Part II, will discuss the remaining five issues to consider.
Interest Averaging
If you are considering assuming an existing first mortgage because the rate and term are attractive, but concerned about the current interest rate of second mortgage financing, do an interest average calculation. You might find the average interest rate to be quite acceptable. Here is an example of how you calculate it:
1st Mortgage $60,000 x 5% = $ 3,000
2nd Mortgage $30,000 x 8% = $ 2,400
$90,000 X “x”% = $5,400
Average interest rate “x” % = $5,400/$90,000 = 6%
Interest Rate Options
There are various ways to calculate the interest: the fixed rate, which means the interest rate remains fixed for the period of the term of the mortgage (for example, three years), and the variable rate, which means that the interest rate could vary every week or month, according to the premium interest rate set by the lender every week or month. In this latter case, although the actual monthly payments that you would make would usually stay the same, the interest charge proportion of that monthly payment of principal and interest will vary with that month’s rate.
How often interest is compounded – in other words, the interest charged on interest owing – will determine the total amount of interest that you actually pay on your mortgage. Obviously, the more frequent the compounding of interest, the more interest you will pay. The lender can compound the rate of interest at any frequency desired. That is why it is important for you to check on the nature of the compounding on interest.
By law, mortgages have to contain a statement showing the basis on which the rate of interest is calculated. Mortgage interest has traditionally been compounded on a half-yearly basis. If a mortgage is calculated on the basis of straight interest, that means there is no compounding, but just the running total of the interest outstanding at any point in time. Some mortgages, such as variable-rate mortgages, are compounded weekly or monthly. The rate quoted for a variable-rate mortgage is called a nominal rate, whereas the equivalent rate for “traditional” mortgages (compounded semi-annually or annually) is called the effective rate. As an example, a mortgage which quotes a nominal rate of 5% has an effective rate of interest of 5% when compounded yearly, approximately 5.20% when compounded half-yearly, and approximately 5.40 % when compounded monthly.
Payment Schedules
There are many payment schedule options available in the marketplace, including weekly, biweekly, (every two weeks), monthly, semi-annually, annually, and other variations. Generally, the more frequently you make payments, the lower the amount of interest that you will be paying. Obtain a copy of the breakdown showing the actual savings before you commit to making more frequent payments.
Depending on your negotiations with the lender, you may make payments on interest only, or have a graduated payment schedule, which means that at the beginning of the term of the mortgage your payments are lower and increase over time so that at the end of the term the payments will be considerably higher. The reason for this type of arrangement is that the ability of the borrower to pay the payment will be able to increase over time, and the payment schedules are graduated to accommodate that.
Normally, payments are made on the mortgage that are a blend of principal and interest. These have traditionally been amortized assuming a monthly payment basis.
Assumability
Assumability means that the buyer takes over the obligation and payments under the vendor’s mortgage. Most mortgage contracts deal with the issue of assumability very clearly. The lender can agree to full assumability without qualifications, assumability with qualifications, or no assumability. Generally, it is with qualifications, eg creditworthiness of the person wanting to assume it.
The issue of assumability is an important one to consider. You would be able to have a wider range of potential purchasers interested in buying your home if a purchaser could assume the balance of the term (e.g., 10 years) of a low interest mortgage in a prevailing high interest mortgage environment.
Portability
Some lenders have a feature called portability. This means that if you sell one home and buy another during the term of your mortgage, you can transfer the mortgage from one property to the other. Check carefully though. Some lenders require that you purchase the new house within a short period of time after you sell your original house, in order to qualify for this transfer or mortgage rate continuance option, e.g., two to four months. Other lenders require that you transfer the mortgage to your new home concurrently as you sell your old home. In practical terms, you could save money if interest rates have gone up before buying the new home. Otherwise, you would be taking out a new mortgage for your new home at current, higher mortgage rates, thereby resulting in lower mortgage amount availability.
Remember, the higher the interest rate, the lower the mortgage amount that you qualify for. Conversely, if mortgage rates have done down since you bought the first house, you would probably not at all be interested in transferring your existing mortgage unless you had a fixed-rate mortgage, with a mortgage differential penalty that was larger than the savings, by taking out a new mortgage.
