Isn't the world of advertising great, for those who can afford
it? This week we'll try to expose some of the mortgage games that
are being played on you, the Consumer. When you have mega dollars for advertising,
it can make some people believe. Several mortgage lenders have started
advertising a product that gives a reduced one year mortgage IF YOU SIGN
UP FOR FIVE YEARS. The five-year term is closed but will allow some
prepayment privileges. The product is being pushed by two of the
major banks and one trust company, so far.
I ran a little amortization test, comparing the scheme (offered by
one of these lenders) to a true discounted rate, offered by the same lender.
This lender has even offered me a greater commission to me for "selling"
the deal. Here is how it works . . . If you sign up for five years,
this lender will give you a discounted rate of 4.5% for the first year
(compared to the regular rate of 6.30%), followed by the next four years
at their present posted rate of 6.75%. As the ad goes, this
will reduce your mortgage payment during the first year so you can use
the savings to pay for the extra costs of home ownership.
Let's use real numbers. You require a $100,000 mortgage, the
payments during that first year work out to be $554/mo., then increase
to $685.05 in the second through the fifth year, amortized over 25
years. The lender is suggesting that you may need the difference
($130) to pay for surprise bills, such as water and sewage, that your landlord
used to pay. By increasing your cashflow (disposable cash) for the
first year, it would appear that they are doing you a favour. But
are they? After the first year, the amount of principal reduction
slows down considerably, because the mortgage rate has gone up to 6.75%
from 4.5%. The balance outstanding after the five-year period will
be $90000. That is a great reduction from the original loan amount,
that is the good news! The ad goes on to say that if you can manage
the higher payment ($685.05) the first year (accelerated plan) as in the
subsequent years, you could save even more . . . a balance of $87850 after
five years. That is even better news! They are playing
the old "shell game." Your better choice (which they do not advertise)
would be to hold out for a rate reduction at the onset for the full five
year term. If you are credit worthy, you should be able to negotiate
an interest rate of 6% for the whole five years. If you were able
to afford the $685.05 above, you should be able to afford the same payment
with a discounted rate. I ran an amortization schedule on that and
guess what I discovered . . . had you chosen the latter deal (discounted
rate to 6% for the whole term), the overall balance in five years will
be $86686, a full $3300 less than the original 4.5% scheme, and $1200
less than the accelerated 4.5% plan. I would say that whatever the
savings, it fits much better in your pocket than in theirs, don't you agree?
The lender is quite right in advising you that costs for that first
year of home ownership may be a little surprising. Had you done your homework
properly though (including reading previous articles in your Sun) you would
have seen that the qualifying standards with most lenders are based solely
on your debt to income ratios (GDS and TDS). Those are the calculations
of payment amounts versus your provable gross salary. In my mind,
you should also compare the new mortgage payments (inclusive of property
taxes) to your existing rent payments. If the difference between
the two is too great, you may be bitting off more than you can chew, as
the old saying goes. In other words, if you were paying $800 in monthly
rent today, and your new mortgage payments are going to be $1200, can you
afford the extra $400/month? If the lender were to lower your payments
the first year by $130, only to jack it up again next year, would you be
able to find the extra money this year, as well as next? I don't think
it is a matter of one year, I think it is a matter of proper qualification
at the beginning. So now you know better.
When a lender is offering a deal for reduced payments and you find
that a great thing, check your cashflow. You will be further ahead of the
game if you choose a discounted rate rather than a scheme. Keep your
payments as high as you can afford and you are the winner.