Interest rates have nowhere to go but up. No doubt you’ve heard this line if you’ve bought a home or had to renew your mortgage at some point in the past decade, followed by an eager banker or mortgage broker urging you to “lock-in” now.
Most homeowners in Canada prefer fixed rate terms for predictability and peace of mind, with five-year terms being the most popular. Yet despite its popularity, the five-year fixed rate is likely the least advantageous term for borrowers.
Going Long: 10-Year Mortgage Term
For those looking for greater protection against (eventual) rising interest rates, a longer term is worth a look. A 10-year fixed rate mortgage today can be had for as low as 3.69 percent.
Another reason to consider a longer mortgage term: a safeguard against the possibility of a housing crash. What happens if prices fall 20 per cent or more in the next few years, wiping away your home equity before it’s time to renew? A 10-year term, while more expensive than a shorter term, does offer a double-dose of protection in case prices fall or interest rates rise substantially.
Certified Financial Planner Ed Rempel doesn’t buy the safety argument, saying that the risk of rising interest rates is ‘hugely exaggerated’ in the media and by the mortgage industry.
“Long mortgage terms are marketed as “insurance” to protect against a possible rise in interest rates. But most people are not good at math and don’t take into account the extremely low odds of a large rise, plus the huge cost of the insurance,” said Mr. Rempel.
A five-year fixed rate mortgage costs around 2.64 percent today while a two-year fixed comes in at 2.29 percent. Mr. Rempel says the difference doesn’t sound like much, but on a $300,000 mortgage this 0.35 percent premium costs $2,100 after tax for the first two years.
“This is expensive insurance to protect against a highly unlikely event,” said Mr. Rempel.
Stop Short with a 1-or-2-Year Fixed Rate Term:
If long-term mortgages offer peace of mind (for a premium), a short-term mortgage – such as a one-or-two-year term – gives homeowners the opportunity to save money in exchange for a bit of uncertainty when it comes to future interest rates.
With a one-year term, for example, homeowners get more flexibility because they can renew their mortgage in 12 months instead of in three-to-five years. At that time they can renew into another one-year term, lock-in to a longer-term fixed rate term, or take a variable rate at presumably a better discount than today.
Those who opt for a one-year fixed rate can also lock-in their renewal rate in just six to nine months – they don’t have to wait a full year.
So why don’t more homeowners choose a one-year term? According to data from Mortgage Professionals Canada, just one in 16 borrowers take a one-year fixed rate mortgage.
Mr. Rempel says that’s because people don’t want the headache of renegotiating every 12 months. But it’s a mistake to give up that negotiating power.
“From a financial planning perspective, I find that most people can benefit from some type of refinancing every two years,” he said.
The bottom line: Homeowners looking to save the most money year-over-year should consider a short fixed term of one-or-two years, while those looking for maximum peace of mind can find comfort in a 10-year mortgage term at rates under 4 percent.
All across the country, university and college students are finally donning their robes and mortarboards and stepping across the stage to receive their diplomas. It’s an exciting time. For many new graduates, it may be the first real taste of independence – finding a job, a place to live, paying off those student loans.
It can start to seem a little overwhelming. Here’s a roadmap that new grads can follow for financial success.
Keep living frugally
Although it may not really be what you had in mind when you threw your cap into the air, graduates who temporarily move back into their childhood bedroom can save far more than their classmates who are living in a downtown high-rise apartment with amenities. It also gives you the luxury of a patient job search – and you know your parents won’t kick you out of the house.
Once you find that job, don’t rush out to buy a new car. In fact, don’t rush out to buy anything. After housing, the biggest drains on a budget are usually eating out, entertainment, and clothes. After years of being a student, chances are you’re used to living on the cheap. Now that you’ve started receiving a regular paycheque, you may be tempted to start spending it on all the things you couldn’t afford when you were a student. I don’t expect you to sit on the couch with your parents and watch Netflix every Saturday night, but do try to ratchet down your spending and maintain your frugal habits for as long as you can. You don’t want to rely on the Bank of Mom and Dad forever.
There will be plenty of time to upgrade your lifestyle in the years ahead.
The first steps to being money-wise
Start with the basics. You need to make a list of what you earn and what you spend; what you own and what you owe. Write down all your obligations and the required monthly payments.
Creating and sticking with a budget on a consistent basis is important at any age. Start estimating and tracking your expenses. Don’t forget to include a category for fun, too.
There are several smart-phone apps available that make the job easier such as the popular Mint, and, for the entry level budgeter, Wally for iOS.
Over time you will develop a system that works for you.
Pay off your student loans
The average student debt load has climbed to over $28,000.
If you have student loans, you will need to start making payments. Student loans give you a six-month grace period, which gives you time to get financially settled. Interest will continue to accrue during your grace period, so starting payments as soon as possible helps you avoid substantial interest charges. Find out when repayment starts, how to make your payments and your payment options.
To help new graduates who are struggling to find optimum employment, the government will no longer require repayment of student loans issued under the Canada Student Loans Program until they are earning at least $25,000 per year (2016 federal budget).
Even though student loans have low, tax-deductible interest rates, they are still financial obligations.
If you are truly in dire straits, contact the lender of the student loan. Explain your situation honestly. There will be some way to help you out. Don’t just simply miss loan payments.
Not making these loan payments will affect your credit rating. Your future car loan or mortgage is on the line.
Start thinking about your future
Spare at least a couple of minutes to think about your future. It’s not typically something most students have seriously thought about. What are your long-term goals? They may pertain to your career, but could also involve where you want to live, marrying your college sweetheart, starting a family and buying a home. Think about where you want to be financially in, say, ten years time. Make a bucket list of the goals you want to achieve in life and when, e.g.– “I will buy a house at 35.”
This helps you start focusing on financial goals and ensures you’re earning and saving enough to support them. Plus, you can start taking the steps to get where you want to go.
Save what you can
Once you are working, with cash coming in and your obligations being covered, start your savings plan. Target a certain amount to put aside every month. Save what you can, even if it’s only a few dollars a week. You’ll be surprised at how quickly it adds up.
You can start with a simple savings account. That will give you the liquidity and resources to make important purchases when the time comes.
A Tax Free Savings Account is also a great way to save for important goals. Know the various rules about contributions and withdrawals.
One of the most effective ways to build wealth is to always pay yourself first. Saving and investing early helps a young investor use the power of compounding to their advantage.
Stop thinking you’re too young to start planning for retirement. Retirement may seem a long way off, but if your employer offers a company pension plan, there are huge advantages to joining as soon as possible, especially if your company offers matching contributions.
In time, you can open an RRSP which lets you contribute 18% of your earned income from the previous year. In return you get a tax deduction. Funds grow on a tax-deferred basis until you make a withdrawal. RRSPs are generally for longer-term retirement planning and useful once you get into higher income brackets.
You are at exactly the right stage in your life where you can start with a blank slate, create a financial plan for your future, and begin a disciplined approach to saving, investing, and money management. Stick to it and you can achieve great things – and probably a lot sooner than you expect.