25 Sep 2019

I have a suggestion for you.

If you value your time, and like to be productive, never, ever, ever, spend time on Twitter. It literally is like a time vacuum that simply sucks the seconds away without you even noticing. It’ll get you angry, riled up, and annoyed at the misinformation on there. So many opinions flying around that you can’t keep up trying to right the wrong ones. Yet, I’m a fool, so last night I went on Twitter to take a look at the reax about the new PC plan to extend amortization to 30 years. And then I saw this nugget:

And right there, BANG, I was engaged.

Let’s recap what’s going on here.

If you’re buying a property with less-than 20% down, you can only amortize to 25 years nowadays. Gone are the days we had 40, then 35, then 30. It’s 25, MAX. The Conservative party decided to counter the Liberal “Shared Equity Program” by offering a simple solution: Extend amortization to 30 years for first-time buyers with less-than 20% down.

According to Urbanation, the average price of a condo in Toronto is now $579,000. Using this as our metric, let’s compare 25- vs- 30-year amortization using today’s rates at the minimum down payment: $32, 900 (Remember, the first $500K of a purchase needs 5% down, and any dollar over needs 10% down = $25,000 plus $7, 900 = $32, 900 total down). Including CMHC insurance, your total mortgage works out to $567, 944.00. So, here’s the math.

At 25-years, 2.69%, 5-year fixed – your payments would be $2598.25 per month, and in 5 years you’d have owed $482, 522.56 assuming you have not made any pre-payments and pay monthly. Over the first 5 years you pay $70, 743.56 in interest, $85, 421.44 in principal. Therefore, the split is 46% interest and 54% principal.

At 30-years, 2.69% 5-year fixed – your payments go down to $2296.10 per month, and in 5 years you owe $501, 896.80 – nearly $20,000 more. Over the first 5 years, you pay $71 718.80 in interest and $66, 047.20 in principal. The split is 53% in interest and 47% principal.

You pay nearly the same interest cost and you pay 7% less in principal. To say that the first five years is nearly an interest-only period is completely and absolutely wrong. You’ve forced yourself to save $66 047 in principal PLUS your (hopeful) capital appreciation in the property (minus, of course, real estate fees if and when you sell).

This brings us to the second point that @WTFoch (a very very clever handle if you ask me) made:

Yes! Good point! As is evidenced by my example above you will owe $19,000 more therefore you will have $19,000 less in equity IF you are looking at making a move at the 5-year mark. Does this mean you can’t make that move? I don’t know. It all depends on what happens to the property market you are in, and to the value of the property. I would tell any sane person not to count on the value going UP, and to try and take advantage of very liberal pre-payment options to counter this equity loss. Yet, it’s still possible you will have $19,000 less if you don’t do any of those two things.

What are my pre-payment options?

One of the easiest ways to counter this equity loss is by setting your payments to bi-weekly accelerated. Most people I work with get paid twice per month, 26 times per year. Using this tip, you would pay $1148.05 every two weeks 26 times per year and in 5 years owe $489, 532 vs $501, 896. Now we have shortened that gap to $7010 less in equity over the 5 years, taking 30-year amortization, but paying bi-weekly accelerated payments. Not to mention any other pre-payments you make you would hit principal faster.

So what’s the point of this whole rant?

The point is simple 30-year amortization plan would not set you in interest-only for the first 5 years. At today’s rates you are paying 7% less in principal and very slightly more in interest over that period. You can try and minimize the gap by paying bi-weekly, thus slowly chipping away at the iceberg debt mountain, without really realizing it.

The other point is – don’t rely on twitter to get you the information you need. It’s sometimes inaccurate. (With all due respect to @WTFoch, who, I will say, has been nothing short of fun to engage with and I’m sure his intent was not to misinform but rather, a misconception?)

Thanks for reading. I’m happy to be writing again. Share away!

 

 

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