When it comes to buying a home as a first-time home owner there are so many things to keep in mind, understand and make decisions about, it can be very difficult if you’re not fully understanding how each step in the mortgage process and what each of the decisions you make will mean for you and your family long term. Two of the most important details to think about when securing funding for your new dream home is how much your mortgage payment will be each month and how often will you make those payments.
But why are those two details so important? Because they could make or break your monthly cash flow and your financial well-being long term.
When buying a home, it’s very easy for home buyers (especially first-time home buyers) to overestimate how much they can truly afford when it comes to the overall amount of the mortgage they take on. Sometimes what the bank or lender is willing to pre-approve you for isn’t realistic for your lifestyle and can leave you mortgage broker, scraping together enough money for the grocery bill each month and a shift in your date night going from dinner at the Keg with your friends to no-name brand chips on the couch with a DVD you’ve seen ten times because even Netflix and internet are out of the budget. On the other side of the coin, I’ve seen many individuals take on a huge mortgage and secure a mortgage with the lowest possible monthly payments, a very long amortization and a sky-high interest rate working to the banks favor instead of the home owners without them even realizing it.
So, what is the best frequency for you when it comes to your mortgage?
The simplest way to figure out what makes the most sense to you is to put together a general budget. Outline the amount you think you would spend in one month on groceries, cell phone bills, cable, car payments, child-care, loans etc. and make sure you include everything you can think of in terms of your monthly costs. Even including an ‘accidentals’ or ‘extras’ column with a cost ensures you’re covering any little things that might pop up in the month that you may have overlooked originally. Then add them all up and compare the overall tallied amount to your monthly income after taxes. Once you take the amount of month that you bring in each month, and subtract a number of your expenses. For example, if you make $6,000 per month and you spend $4,500 per month before you add in your mortgage payment, taxes, heating and hydro bills you don’t want to sign on for a $2,000 a month mortgage payment as it would increase your monthly costs to well over $6,000 a month. AND unless you foresee a big raise in your very near future (ie. before you finalize the mortgage) or plan to take on another job to pay for the excess, doing so won’t be a good investment in your future because even if you can make the payment, you won’t have much extra in the budget for the fun things you’ll want to do over time, or any savings for your retirement fund.
Monthly costs aside though, why is the frequency important to decide upon?
Well, how often you make your mortgage payments and the amount of interest you pay to your lender over time actually go hand in hand. When you secure your new mortgage or even renew an existing mortgage you have a few options in terms of your payment schedule. You can pay one amount monthly, you pay your mortgage payment bi-weekly (meaning every two weeks) or you can do what they call an accelerated bi-weekly payment and each option actually affects the amount of interest you pay over the duration of your amortization (the length of time it takes you to pay off your mortgage in full). To help explain the difference here’s a quick example of the interest incurred with each frequency of payment.
Let’s say your mortgage payment was $800 per month.
If you paid it monthly you would pay $9,600 off on the principal amount of the month each year.
If you paid it bi-weekly you would pay $400, 2 times per month and as there are 12 months in a year, and you make your payment twice per month, that means that you would actually make 24 payments per year of $400 which would also pay $9,600 off of the principal amount each year.
If you paid it accelerated bi-weekly you would pay $400, every two weeks and as there are 52 weeks in a year, and you make your payment every 2 weeks, that means that you would actually make 26 payments per year of $400 which would pay $10,400 off of the principal amount each year.
You also have the option of making payments weekly, and with 52 weeks in a year if we divide the monthly amount we had been talking about of $800 by 4 weeks that would make your weekly mortgage payment $200 but if you were to make those payments accelerated weekly payments meaning that you make a payment every week all year long instead of just 4 times a month. You’d also pay $10,400 off your principal amount each year.
So not only would you pay your overall mortgage over sooner (as much as 5 years sooner even) you’ll pay MUCH less in interest over the duration of your mortgage. As the monthly interest charged would depreciate at the same rate of which you depreciate the principal amount of your mortgage. If you do choose the accelerated route, and end up reducing your mortgage by 4 or 5 years — That’s 4 or 5 years without any mortgage payment OR interest which is nearly found money that you can put towards other fun adventures or into investment funds for your children’s education or your retirement fund.
When it comes to signing on for a mortgage loan, there’s much more to it than just signing on the dotted line and waiting for moving day. If you’re thinking of buying a new home as a first-time home buyer or if you’re renewing your mortgage shortly, let’s setup a quick one on one to take a look at your options, your financials and see what makes the most sense for you and your family before you finalize your mortgage to ensure you’re taking advantage of any possible savings while also getting a great rate too. Just give me a call at 705-315-0516, I’m here to help you in any way I can and will always have your best interest in mind.