Considering payment shock (and what you can do about it).
If you were one of the lucky Canadians to nab your first home when rates were at their historic, sub-2% lows then you’ve probably already started to consider the shift that will happen when your term is complete. With fixed rates now surpassing 5%, you could be facing a payment increase that will have a significant impact on your monthly budget - a phenomenon known as payment shock.
Making any significant adjustments to our household budgets can be daunting at the best of times, but with a recession looming an extra level of concern is absolutely valid.
But there are some things that we can do as your mortgage professionals to ensure that your budget stays on track, your payments stay feasible, and you are not thrown for a loop when you renewal rolls around.
Utilize Prepayment Privileges
We talk a lot in the mortgage space about prepayment penalties (or the fees incurred when a fixed rate mortgage term is broken before maturity). However, most fixed rate mortgages also come with some prepayment privileges which allow the borrower to make extra payments throughout their term without incurring any penalties. In many cases, these terms include the ability to incrementally make increases to payments each year. Typically, lenders allow for around a 15% increase yearly. So, let’s look at an example of what this could mean:
If you started out with a $500,000 mortgage at a rate of 2.65% (with a 25 year amortization) in the past few years, your payment is likely around $2200.
On renewal in 2 years (though it is very difficult to speculate rates that far out), let’s overshoot and guess your new rate will be around 6%, your new balance will be around $440,000, and your amortization will be 20 years. This will bring your payment to roughly $3100.
If you take advantage of prepayment now, you could increase your payment to about $2600 now, and $3000 in another year. This will mean that when renewal rolls around you will have already had a chance to work smaller increases into your budget!
What are the advantages here? Of course, the opportunity to adjust your budget slowly will be beneficial. However, it’s also important to note that any prepayment made goes directly to your principal balance. This means that those extra few hundred dollars each month will be hammering the core of your mortgage, and shaving time off of its total lifetime.
Restructure at Renewal
If you would prefer to leave things how they are until your renewal rolls around to continue enjoying lower payments, we get it. Sometimes our budgets just don’t have the wiggle room! But remember, just because we will be in a higher rate environment at renewal does not mean that you will be forced to just take the first rate handed to you and that’s that. There are always options to restructure, including extending your amortization, so that your payments can remain as low as possible.
If you think you might prefer to go this route, we still recommend connecting now to discuss all your option. In this environment, it is always best to have as much information as you can, as early as possible, to make the most informed decision for you and your family. We are open books!
Take Advantage of Equity
If you have been in your home a bit longer - say, if you are in your second term but have still become accustomed to a lower payment - you may have the option to take advantage of your equity and restructure your mortgage before renewal comes around. In this case, you may be able to refinance into a fixed rate, even at a shorter term. A 3 year fixed rate, for example, will mean you will not be married to your rate for quite as long and will be able to renew sooner when rates have come back down.
In most cases, this option will mean incurring a prepayment penalty for terminating your current fixed term early. However, with property values still quite high, there are cases in which the proceeds from a refinance may actually cover those costs to leave you coming out on top!
Whichever way you decide to go, we are here for you. We understand that the economic environment is daunting right now, and don’t want anyone to feel like they aren’t well-resources in making the best financial decisions for themselves! If you are concerned about what your renewal will bring for you, or simply have questions about what is happening in the market, reach out to our team today. We got you!
