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June 11, 2010, 6:38 am

Interest Rate Calculation – Mortgage Payment

by: The Financial Blogger    Category: Banks and You,Properties

I don’t know about you but I am growing tired of the media telling us how high interest rates will become in a year or two. They keep writing in the papers about interest rate calculations affecting your mortgage payment if the prime rate goes up by 5%. Some of them even push the limit saying that the prime rate will be 7% within 5 years… how the hell would they know? Did they tell the world in 2003 that prime rate would it 2.25% for 18 months in 2008? Who was right back in 2003? Please, give at least one name!

So today, I’ll do something different. I’ll use the very same math to perform interest rate calculations that affect your mortgage payment, but on the other hand. Since the mass media always tend to show you how much you *might* pay if the prime rate goes up by 2% compared to a fixed rate, let’s take a look at how much you *paid* in excess since 2008 compared to a fixed rate.

So let’s take an easy example:

Mortgage; $200,000

Amortization: 300 months (5 years)

Negotiated 5 year Fixed rate: 3.85%

Negotiated Variable rate: P+0 = 2.25% for the first year, now at 2.50%

Before I start with my calculation, you can argue that you were been able to lock your 5 year rate at 3.69% or even lower, but I could argue back that some of my clients are paying way less than P+0, so let’s keep it this way.

So during the first year, you would pay $12,430.08 in mortgage payments if you had taken the 3.85%. With the variable rate of 2.25% during the first year, you would have paid $10,454.64… so 2K less for the first year.

Let’s assume that the prime rate will go up during the next 12 months with an average of 3% (which includes that it increases from 2.50% to 3.25%). Your mortgage payments will go up to $11,357.88 for the year. So you will be saving another 1K during this year.

So you start year 3 by paying 3K more in interest with your fixed rate or by applying the very same 3K on your mortgage to create a safety net. Let’s assume that you just took the 3K in your pocket and you keep the same strategy (either paying 3.85% fixed rate or 3.25% variable rate). And let’s imagine that the prime rate goes up to 4.50% (with an average rate of 4%). Your mortgage payment with this new interest rate increase would be $12,624.48.

So after 3 years, and a lot of interest rate increases, you have still saved a total of $2,853.32. So let’s push the interest rate higher to 5.5% with an average of 5%. Mortgage payments for the year totals $13,958.52.

So after year 4, your overall mortgage payment is still lower and you have still saved $1,324.88.

When we look at this scenario, you will be a loser if interest rate keeps increasing for 5 years in a row which is unlikely to happen. And if it does, you will have lost about $1,000 compared to the fixed rate. Then, if you keep with the variable rate for another 5 years instead of locking a very high 5 year term fixed rate (because if Prime = 5%, the 5 yr fixed rate could be around 7 to 8%). You are almost sure to see a decrease in interest rates during the next 5 years since we always go through economic cycles.

Final thoughts on interest rate calculations and mortgage payments

Based on these calculations, I am a firm believer in the variable rate but by simulating 5yr fixed rate mortgage payments. i.e. , you pay low interest rates (prime) but you make higher payment (simulate it a 4%). Therefore, you are building a huge safety net to compensate if the variable rate goes higher.

See, the future is not always black when we talk about variable rates 😉

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June 1, 2010, 9:08 am

Bank of Canada Increases Interest Rates By 0.25%

by: The Financial Blogger    Category: Banks and You

A very small note this morning as the Bank of Canada has finally decided to increase the overnight interest rate to 0.50%. This interest rate increase will obviously pushes Canadian banks to increase their prime rate from 2.25% to 2.50% in the upcoming days.

The recent positive economics datas (economic growth, inflation and drop in unemployement rate) are the most important reasons leading to this interest rate increase.  The Bank of Canada doesn’t consider that the economic problems from Europe should affect its future economic growth that much and I guess this is why we see a interest rate increase of 0.25% today.

The next schedule for the interest rate revision is due on July 20th. While this interest rate increase was expected, any further increase should be done very carefully as we are still going out slowly of the previous recession. Some economists report that they are afraid to see the Bank of Canada increasing their interest rate too fast as they did in 2002.

In my opinion, I am not very surprised about today’s increase. I was expecting no change to an increase of 0.25%. on the other side, I don’t think this event is the signal of the low rate party ending. I think we have another good 6 months to 12 months of low interest rate 😉

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May 28, 2010, 6:38 am

Looking Forward: The Bank of Canada Prime Rate Decision on June 1st 2010

by: The Financial Blogger    Category: Banks and You

Next Tuesday, The Bank of Canada will announce the new (or unchanged!) Prime Rate. For several months now (since the credit crunch of 2008), The Bank of Canada has maintained its prime rate at the virtually lowest level possible; 0.25%.

We started to read about potential rate increase in late 2009 when Australia had increased its rate several months in a row. However, the Australian reality appears to be quite far from that of the Canadian economy.

Controlling Inflation

The most important reason why the Bank of Canada would increase their interest rate would be to maintain the inflation at an “acceptable” level. This level is currently set between 1% and 3% with a “ideal” rate of 2%.

Since we have been flirting with the 2% inflation rate for a while (currently at 1.9% as of April 2010), many economists have predicted that the Bank of Canada would start increasing its interest rate as previously mentioned by Mark Carney, Governor of The Bank of Canada.

There are more clouds in the sky than expected

The Bank of Canada was ready to stop the low interest rate party this summer but recent events in Europe might cause the Bank reconsider its strategy. Considering the economic problems stemming from the PIGS (Portugal, Ireland, Greece and Spain), the stock market has responded negatively.

Therefore, the economy may slow down again and reduce the inflation risk. Considering this scenario, there is no urge to increase the prime rate right away.

The general demand for resources is slowing down as the price of oil has dropped significantly. This will also have an important effect on inflation (even though they consider the inflation rate with and without the price of oil).

What is my bet on the Canadian Prime Rate?

I bet it will increase by 0.25% but I would definitely not be surprised if it stays at 0.25% until July. The only point I am quite confident of is that we won’t see an increase of 0.50% or 0.75% as some economists were predicting a few months ago.

It’s not that they were wrong in the predictions; it is just that today’s economy evolves so fast that your 5 year projection are probably right when you do them but they go wrong 2 weeks later ;-).

I hope to benefit from low interest rates till the end of 2010. This would help me stabilize my finances after my moving in June. This fall, I will seriously attack my mortgage so it starts decreasing faster than it has been for the past 2 years!

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April 28, 2010, 5:21 am

How to Get a Bridge Loan?

by: The Financial Blogger    Category: Banks and You,Properties

Can banking get any more complicated? Hey man, you have no clue ;-).  But in fact, clients can make banking and the loan industry complicated:

At first, somebody wants to buy a house but doesn’t have any cash available for a down payment. So, banks create mutual funds to help him save.

Then, this same individual can’t manage his budget so he can’t really save. And, banks come up with RRSP loans.

Now that he has a 5-10% cash deposit saved, he now wants to buy his house right away. Therefore banks offer him a mortgage.

But the guy wants more flexibility as he wants to make home renovations and buy a new car. So the banks create the home equity line of credit.

And guess what? The same guy doesn’t want to manage notary/lawyer’s dates while buying and selling properties. This is why banks created a bridge loan.

What is a bridge loan?

A bridge loan is a very interesting product for individuals who don’t want to bother about dates when selling/buying their properties. A bridge loan is a short term loan that advances the amount of your cash down temporarily between the sale of your current house and the purchase of the new one.

Why do you need a bridge loan?

Picture this: you have a house selling on June 13th (the moment you will receive your check) and you give the keys to the new owner on June 17th. You finally find the home of your dreams and you are getting the keys on June 12th. Therefore, you will have to give the seller your check before that date. Let’s say that you have to pay him on June 9th. The bank will disburse your mortgage on June 9th, but where will you find your cash down if you are getting the money from the sale of your house on June 13th? This is why you have 2 options:

#1 You ask your buyer to accelerate the process and go to the notary on June 6th so you can get your money ready for June 9th. However, if the buyer pays upfront,  he will want to possess the house faster. If he only gets the keys on June 17th, he will request compensation for the 11 days that you live in “his” house for “free” (since your mortgage will be paid off on June 6th at the time of the sale.

#2 You keep the dates as is and ask for a bridge loan from your bank! The bridge loan will be disbursed on June 9th (the date you are buying) and the bank will also disburse your new mortgage so you have the whole amount to buy your new property. Therefore, on June 9th, you will be responsible for the 2 mortgages (since you haven’t sold your house yet) and a bridge loan (which is the equity lying in your previous property that is not sold yet).

On June 13th, you will receive the check from the sale of your house but the bank will demand from the notary/lawyer to be paid first for #1 the outstanding mortgage and #2 for the bridge loan.

What is the cost of a Bridge Loan?

They used to have a basic fee for a bridge loan since it is a temporary loan where banks don’t make much money on it (imagine the interest rate of 5% on $50,000 for 5 days… you don’t get much from it!). However, since competition is pretty rough, banks tend to wave bridge loan setup fees in order to make sure they get the mortgage!

What is the interest rate on a Bridge Loan?

It is usually comparable to the interest rate on unsecured personal loan. In fact, bridge loans are unsecured loans (but they are set on a very short amortization).

What is the maximum amortization for a Bridge Loan?

There are no specific rules about bridge loan in terms of amortization. Since the bank is still taking a risk, they usually don’t extend bridge loan for more than 90 days. Otherwise, your bank will require that you renegotiate your possession dates instead of asking for the bridge loan.

What do you need to get a bridge loan?

Basically, the bank will require that the 2 transactions are almost certain. Therefore, they will need your purchase and sale contracts with financing approval for all parties involved. The bridge loan will be disbursed at the same time as your new mortgage and you don’t have to do anything to manage it. The repayment date of the bridge loan will be set according to your sale date at the notary/lawyer. The bank’s main requirement in order to grant the bridge loan is obviously to get the final mortgage (we don’t work for nothing after all 😉 ).

After giving some thoughts about it, I will be going for the bridge loan instead of managing date with buyers and sellers. The bridge loan won’t cost me much and it is definitely an easy way to get everything done without headaches!

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April 16, 2010, 5:00 am

The Cash Back is Back… Is it a Good Thing?

by: The Financial Blogger    Category: Banks and You,Properties

A few weeks ago, you were making one of the most important moves of your life. You have been discussing this plan for a while, you have dreamed about it and you finally did it. Your dream will come true in a few weeks and you just can’t wait to smell the odour of fresh paint in your new living room of first new house… A few weeks ago, you signed an offer to purchase your new home, congratulations!

But before sitting in your brand new couch in your brand new house, you need to get a brand new mortgage ;-). This is when you come across a huge billboard advertising a cash back of 5% 5.5% on your mortgage. Man, this is perfect! You were just thinking of renovating the kitchen! Hey wait… your mortgage is $200,000… this means that you will get $10,000 in your pocket to buy that house! VIVA EL CASH BACK! Not so fast buddy…

Why are you getting huge cash back on your mortgage?

Before we start about whether mortgage cash back is good for your situation or not, you need to understand how a bank does its pricing for mortgages. There are 2 things that can be adjusted: interest rates and the amount of cash back. Since the interest rate war has been pretty rough on any banks these the past 12 months, some banks are starting to play on the other side of the equation; they are talking cash back. The more cash back you get in your pocket, the less you can negotiate the interest rate (and vice-versa).

The easiest way to know if you should take the cash back or the low interest rate is to do a small math calculation by comparing both options. Let say that you have a $200,000 mortgage. Therefore, you have 2 options:

–         get a cash back of $10,000 (5%) and an interest rate of 5.85%

–         get no cash back and a low interest rate of 4.35% (you can usually get about 1.00% to 1.50% off the posted rate).

When you see huge cash back mortgage promotions, they usually offer it on 5 year term mortgage (fixed) and give you the posted rate. Then, you just have to calculate (roughly) how much you save in interest over the next 5 years: ($200,000*(5.85%-4.35%)*5years = $15,000. While this is a gross amount (since your principal will decrease according to your payment), you can see that the cash back is not that of a great option. If you decide to go on a variable rate, you will be able to save even more money ;-).

Why take the cash back promotion then?

There are a few situations when cash back is a good thing (while most of the time, cash back mortgage is just another marketing gimmick 😉 ).

#1 You need money now

If you need money to renovate or to buy a second car since you are moving away from your job, the cash back option can help cover those costs right now. Don’t forget that if you save $15,000 instead of $10,000 in my previous example, you don’t get the $15,000 in your pocket, it is just decreasing your mortgage payments over the next 5 years. So if you need a few thousand for a specific project, it may be worth it.

#2 Cash Back for a cash down

Young couples often use the cash back as cash down on their property. It may be a good strategy to buy a house in a hot market. If you wait 2 or 3 years to buy the very same property, inflation will work its magic and it will be more costly than taking the cash back today in order to boost your cash down.

#3 Cash Back for rental properties

This may be a really good strategy for rental property owners. Since the interest rate is tax deductible (and mostly paid by your renters anyway), you are probably better off with additional cash in your pockets (that can cover maintenance, an empty apartment, etc.).

So the Cash Back mortgage promotion is not that bad after all

As is the case for many financing or investing products, cash back mortgages can be a really good idea for some people in specific financial situations. All I am saying is don’t get hooked by the 5% cash back without asking questions and without asking what other mortgage options are  offered. In the end, you could take a variable rate with appraisal and notary/lawyer fees paid instead of taking a huge cash back… just discuss your options with your banker 😉

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