27 Feb 2021

We’re already two months into 2021 and finally we’re seeing some increases in interest rates (fixed-rates). When I say “finally”, I don’t mean this that I’m happy about it. On the contrary! However let’s face it: Low rates were not going to be here forever, and here’s what I want to make sure you know: Avoid the low rate trap!

What’s that?

Simple.

If you took a $750,000 mortgage at a rate of 1.5% and 25-year amortization, your payment is $2977.88 and in 5 years unless you make any changes to your payments, you will owe $621 539.

In 5 years, you have 20 years left, and at $621 539 balance with rates +1%, you will be paying $3289, or an increase of $312 per month.

If rates are +1.5%, your payment will be $3441 at renewal.

If rates are +2%, your payment will be $3596 per month.

You might be wondering.. what!?! Nobody told me this! Well I am telling you this now because it’s extremely important to plan for.

How do I avoid the rate trap?

Luckily since your rate of 1.5% is so low, almost 70% of your payment is going to principal over 5 years. To avoid the low rate trap is quite easy – make pre-payments now while you can, and while your payments are low. Let’s see what the effect of this would be.

A $750,000 mortgage at 1.5% , 25-years amortization, 5-year fixed is $2977. How about you pay as if rates went up to 2.5% at renewal, but from today? Your payment would be $3289 and in 5 years instead of owing $621 539, you will owe $603 414.

Now, in 5 years, if rates are up 1%, your payment will be lower at $3193!

If rates are up 1.5%, your payment will be higher still at $3340 but it’s a much smaller “payment shock” than going from $2977 to $3441 if you keep things as-is, isn’t it?

Make sure during the first five years of your mortgage, you are avoiding the low rate trap by making healthy pre-payments to your loan.

If you can’t, there are options (hopefully). One option is to refinance and reset the amortization clock backwards, back to 25, or 30 years, to have lower payments. I don’t want you to do that though! I want you to be debt-free as soon as possible! To refinance you have to make sure you have at least 20% equity in the property and frankly speaking even if you put down 5% today, you probably will have 20% because our housing market is just completely out of control and unstoppable.

For now.

 

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