You’ll fork out a huge lump of extra interest on a 40-year plan
Jim Yih
Province
Foreclosed house up for sale in Las Vegas, Nev., demonstrates why Ottawa wants to prevent the fiasco that is happening in the U.S. housing market. Getty Images file photo
Don’t pay until 2048 has become a very attractive plan for Canadian homebuyers. But if that’s not enough incentive, the mortgage institutions have also introduced zero-equity mortgages (no down payment) and interest-only loans. These options have become especially attractive for first-time homebuyers.
Recently, the federal government announced new rules to eliminate 40-year mortgages and zero-down mortgage options. By Oct. 15, you must have a minimum down payment of five per cent and the longest amortization will be 35 years.
The main reason anyone would choose a 40-year mortgage is affordability, and you can blame that on the rising Canadian housing market. Extending the amortization lowers your monthly payments and allows you to get a bigger mortgage for the same payment.
Let’s look at a few simple numbers.
On a $100,000 mortgage at six per cent, with what used to be a normal amortization of 25 years, monthly payments would be $640. Extending the amortization to 40 years would lower the payment to $545. That means you can spend $95 on something other than your mortgage.
Another way to look at this is if you could afford the $640 payments, but you extended the amortization to 40 years, you could now borrow $17,500 and get a more expensive house. Or what some people have done is spent the extra $17,500 for renovations.
Although longer amortizations create greater affordability for housing, it comes at a big price. Lowering the monthly payments simply means we can go into more debt, and more debt means more interest and less equity. These two things are sure to slow down your path to financial freedom.
With the 25-year amortization and at the same six-per-cent interest, you will make a total of $191,943 in payments. That means your $100,000 mortgage cost you $91,943 of interest over 25 years. On a 40-year amortization, your total interest jumps more than 75 per cent to $161,643.
In many cases, you will pay more interest than the original price of the house you buy.
A 40-year amortization will save you $95 per month in payments, but at a cost of an extra $70,000 of interest on a $100,000 mortgage.
There’s no question the government is doing the right thing in preventing people from extending the amortization periods too far. They obviously want to prevent the fiasco that is happening in the U.S. housing market from occurring in Canada.
Moving from a 40-year mortgage to 35 years will save you $24,238 in interest on the same six-per-cent $100,000-mortgage. But you will still pay $137,405 in interest.
It used to be that before you could buy, you had to show you had some financial discipline. Not only did you have to save a significant down payment, but you also had to afford a 25-year amortization.
Some new homebuyers will argue that rising house prices make it impossible to enter the housing market, but remember that buying a home should be a result of some good initial habits. We live in a world that encourages debt — the biggest cancer to financial freedom.
Creating more access to debt may improve our perceived lifestyle, but it comes at a significant price. Just take a look at what too much debt has done to people south of the border.
© The Vancouver Province 2008
