The Bank of Canada just dropped the prime interest rate by 0.25% making it….0.25%. The federal banks quickly followed.
Here are the 6 things you should do right now.
- Call your banker/mortgage broker and reduce your mortgage payments as close to interest-only as possible. Do not go into negative-amoritzation (i.e. where your loan gets bigger).
- If you don’t already have a reserve fund account, open one. High interest savings accounts are good, but 1% doesn’t really matter.
- Set up an automatic transfer to your savings account for your an amount equal to your current debt service payment minus the new payment amount. You’re banking the savings on your mortgage and building up your reserve fund. I agree with Don Campbell that we’re still looking at 18 months before we see serious sustained growth in Canada again. Make sure you can stay above water until then.
- Watch what Mark Carney and the Bank of Canada are saying. Eventually the interest rate will go back up.
- If you’re losing sleep at night, lock your mortgage rate in. If rates start going up or you have better things to do with your time.
- Don’t forget, any interest rate below 10% is just fine. Don’t ditch a good bank or mortgage broker over a half percent.
Now go and pick up the phone.
photocredit:Gaetan Lee
6 comments
LuLu
Great post Chris.
“Call your banker/mortgage broker and reduce your mortgage payments as close to interest-only as possible. Do not go into negative-amoritzation (i.e. where your loan gets bigger).”
What does negative amortization mean? I have a mortgage with RBC (P-0.75, where P was 3), with 35 years amortization. I called today, and the rep said with the old prime, my amortization is 28.x years. If I lower my payment to new prime, I am paying $90/mo less, but my amortization is back to 35 year, and will pay $12K interest in 35 years. I told them to hang on and let me think about it. Does it all make sense?
Chris
Good question. Negative amortization is where your payment doesn’t even cover the cost of your interest. Once you go to interest only payments, you effectively don’t have an amortization period (i.e. you’ll essentially “never” pay off your mortgage). You can go on forever in theory, if you don’t sell.
The upside is that on a monthly basis you’ll have more cash, because you’re only paying the interest portion, not the principle.
If you go negative amortization and you’re paying less than the interest, they’ll just add that on to your total mortgage. That would mean each year you’d owe more, and that’s not a cool situation. It’s much more common in the US than in Canada. As a rule Canadian lenders won’t let you go into negative am territory without a very good reason like extreme hardship.
Jerry Aulenbach, REALTOR®, BEd
Chris,
Could you expand on why you think we should drop mortgage payments to interest-only land?
-Jerry
Chris
Hi Jerry,
Part of yesterday’s conversation covered the times in our history when interest rates were 12-17%, as well as a semi-random journey into one man’s experience in post-war Germany hyper-inflation. The moral of that story is any interest rate below 10% is just fine when taking a 50 viewpoint.
The second part is that there’s little doubt that when approached from 5 year buy-and-hold time frame, investment real estate will do well. The challenge for many people will be the next 18 months or so, where prices may fluctuate and rents may go down in some areas. They’ve come down for some types of units in Kelowna during the last 6-8 months due to over-build.
The reason for going to maintenance payments is to bank the extra cash and build a reserve fund, making sure you’re able do deal with whatever the next year or two brings. The cash is more important than paying down the principle because our ability to leverage the principle has been seriously eroded. When you have extended vacancy, see lower rents, or have to make renovations to increase rent or valuation, you’ll be better with cash then you would with equity that you can’t access.