Is your mortgage sticker price blinding you?
What do I mean with “sticker price,” and what is a mortgage’s sticker price? Your mortgage’s sticker price is what you see about your mortgage; it is the contract interest rate that determines, amongst other things, your mortgage payment. Surely, there isn’t much else to know about a mortgage than the mighty interest rate, right?
Unfortunately not, there is a lot more to know about your mortgage than just the interest rate. Once you understand the whole picture, you will see that financial institutions use the interest rate to distract you from the mortgage’s life-cycle costs. A mortgage’s life-cycle costs can far exceed the interest savings from a slightly lower interest rate.
In this and the follow-on other articles in this series, we are going to name and dive deep into the various components that make up your mortgage’s life-cycle costs. Once you know these and how they can affect your mortgage, you should be able to avoid bad mortgages.
What are the life cycle costs of a mortgage, and how do these differ from the mortgage’s sticker price?
To answer these questions, let’s make a few observations and use some everyday-life examples to illustrate what I mean.
Let’s use men’s dress shoes as an example; assume a normal pair of shoes have a sticker price of $140 while another high-quality, re-sole able pair have a sticker price of $600.
Which is the more expensive pair of shoes? It depends on how you look at it. If you just consider sticker prices, the answer is easy, but if you do the math over 20 years, the life-cycle costs of the cheaper shoes far exceed the high-quality shoes’ sticker price.
Ignoring inflation for this exercise, the cheaper pair will only last you about two years before you must replace them, while the more expensive shoes will last you +20 years with only minor re-soling. Those cheap shoes may end up costing you three times as much as the higher sticker price shoes.
How about a car example? Who of us will go to a dealership and ask for the cheapest car on the lot? Nobody would because we all know “you get what you pay for.”
The cheapest car’s repair costs can easily make it the most expensive car you have ever owned.
Who would ever ask their financial planner to base their retirement planning on perfect and always increasing investment returns, zero risks, and nothing going wrong ever?
Nobody would ever do that because it’s not reality. Instead, we want our financial plans to reflect reality, be achievable and incorporate various “what if” scenarios, risk factors, etc., to ensure we retire safely.
How does all of this apply to mortgages? I have noticed that we typically don’t apply the same common-sense, instinctive logic to mortgages that we do to things like we discussed above.
Why aren’t we more suspicious of “too good to be true, miracle” interest rates? Why are we ok with taking on a bank mortgage without understanding the product first?
Why is my broker so eager to sell me a 4-year term, fixed-rate, when rates are at an all-time low?
Why aren’t we more curious about our mortgages? Maybe it is because we have been conditioned to only ask about interest rates or known features, or maybe it is because we don’t know what to ask? Educating you about your mortgage’s life-cycle costs will allow you to ask good and relevant questions and put you in the driver’s seat when it comes to your mortgage.
As we mentioned above, your mortgage’s interest rate is clearly visible, very defined, and the costs associated with it, easy to calculate.
In contrast, mortgage life-cycle costs are mostly unknown, often hidden in terms & conditions, may become relevant later during the mortgage term, left to chance and are often impossible to calculate.
Because of this uncertainty, mortgage life-cycle costs are often ignored or unwisely shrugged off as improbable yet affect most Canadians.
Life-cycle costs intentionally or unintentionally benefit the lender more than the borrower. They “force” the borrower to be loyal to the lender, restrict/limit the borrower, prevent the borrower from saving money, and can cause the borrower to incur debilitating costs that can erase or far exceed any upfront interest rate savings.
Financial institutions regularly use the mortgage’s sticker price [interest rate] to distract borrowers from inquiring, discovering, and understanding their mortgage’s life-cycle costs.
Below I am introducing the various aspects that can affect your mortgage’s life-cycle costs, but in subsequent articles, I will explore each of these in-depth. In no particular order:
- Interest Rate: Your mortgage interest rate, just like any other product sticker price is important, because it directly determines your mortgage costs, but beware of being distracted by miracle interest rates because they probably include debilitating life-cycle costs.
- Lender Philosophy: Someone once said, “how we do anything, we do everything.” Know your lender, what incentivizes them and how their goals are in conflict of interest with yours.
- Interest Rate Type: Are variable rates always better than fixed rates? What are the pitfalls of each rate type? Is now a good time to take a variable rate?
- Planning & Strategy: Is it ok for your mortgage advisor not to ask you about your goals or explain why they are suggesting a certain mortgage to you? How will this mortgage affect you in the future? When do you want to be mortgage-free?
- Mortgage Product & Loan Type: Your chosen mortgage product has a very large effect on your mortgage’s life-cycle cost. The more complex the product, the more cautious you should be.
- Advocacy & Support: Will your mortgage provider stay in touch with you, and will they provide customer service when you need it? Very few mortgage advisors support their clients after the mortgage closing, which can have a real cost impact.
- Mortgage Penalties: Mortgage penalties are very different for various products and lenders. Mortgage penalties can be prohibitive, and you need to understand them.
- Terms & Conditions: Know the fine print and know where to look for the fine print.
- Pre-payment Privileges: Good pre-payment privileges can help you pay off your mortgage faster and keep you as flexible and untied to your lender as possible.
- Insurance: Having insufficient and/or unsuitable insurance can increase your costs or, in the extreme, cause you financial hardship. Your mortgage lender will offer you insurance, but is that insurance the best for you? Note: I am not licensed to sell insurance and thus cannot and won’t advise on specific mortgage products, etc.
- Term Length: Why is your bank offering you a 4-year term without explaining why, when interest rates are at an all-time low?
- Borrower Short-sightedness: Maybe you need to expect more of your financial institution? By being incurious about your mortgage, you may unintentionally increase your chances to incur significant life-cycle costs.
- Term Type: What is a Closed or Open mortgage? What are the consequences of getting a Closed mortgage?
- Mortgage Rules: Mortgage rules are forever changing. How can they affect your mortgage even after the mortgage has closed?
- Down Payment: How much down payment is needed, and how can your down payment affect your mortgage life-cycle costs?
- Amortization: Put simply, your mortgage’s amortization period is the time it takes to pay off the mortgage if you make only the minimum mandatory payments, and interest rates don’t change for the entire duration of the mortgage. We will explore how your chosen amortization period can affect your mortgage life-cycle costs.
- Payment Frequency: What is the difference between “accelerated” or “rapid” mortgage payments vs normal [non-accelerated] bi-weekly payments? Do normal bi-weekly payments pay your mortgage down faster?
- Portability: In essence, a portable mortgage allows you to sell your existing home and transfer your mortgage to the new home you just purchased. How do mortgage rules affect portability?
- Assumability: In essence, if your mortgage is assumable, a qualified buyer can assume [take over] your mortgage when you sell your property. This very unknown mortgage privilege may come in handy in the future, and you should know about it.
We know there is very little “sexy” about mortgages, but we also know that successful people master and even love the mundane. We are convinced that this content will help you if you apply it, and we feel very blessed to guide you and be with you on this learning journey.
Disclaimers:
- Not for decision-making purposes.
- Subject to lender approval and terms & conditions
- In any and all cases of conflict of any kind, lender rules, guidelines, terms & conditions, interest rates, etc., supersede these.
- Subject to change in any or all ways, at any time, without prior notification or warning.
- Does not include all, may exclude some and/or may only partially represent guidelines, mortgage rules, scenarios, topics, etc.
- These are general guidelines and are not specific to any particular mortgage lender. Lenders don’t all have the same products, underwriting guidelines, etc.
- Subject to all borrowers seeking independent professional advice from any and all providers as determined solely by the borrower, at the borrower’s own and sole discretion, prior to applying for a mortgage/loan.
- E.&O.E.