This week I sat down with a client who has a variable mortgage rate.
Her mortgage rate now sits at 5.85%. Up from 1.5% nearly 12 months ago.
What caught her off guard is that her mortgage payment didn’t change during these rate hikes. So the impact was meaningless to her. Since her renewal was not coming up for 3 more years, she figured she wouldn’t pay too much attention. Especially since she was busy with work and family life responsibilities.
This week was her reality check and after running our models we notified her that her current mortgage payment would no longer pay down her principal. Not an easy conversation to have but certainly necessary, she quickly asked me – “What do we do?”
Option #1 – Increase Mortgage Payment
This option is a cash flow disruptor since homeowners will need to use more of their net after tax dollars to increase their mortgage payment. This option is also an emotional disruptor since clients feel less financially sound. One reason is because more of your paycheck is now being directed to your mortgage rather than accumulating in your bank account. We also have nearly zero price stability at the grocery store and gas pump.
If you can increase your mortgage payments and maintain your lifestyle and savings obligations, increasing your mortgage payment will stop you from burning money each month since your payments are now paying down your principal.
In my client’s situation, we proposed she consider increasing her mortgage payment from $3,020 per
month to $4,600 per month.
Option #2 – One Time Prepayment
Unlike option 1, where your cash flow is immediately affected by rising interest rates, making a one-time payment above and beyond your mortgage payments can create more flexibility for homeowners. Going back to my client’s situation, our model showed that a one-time payment of $20,000 could accelerate her payment schedule and keep her monthly mortgage payment the same.
To generate the $20,000, we could either use the upcoming tax refund she was expecting since she maximized her RRSP or liquidate a portion of her savings including her Tax-Free Savings Account. Any money withdrawn from her TFSA could be replaced in the following year.
Ultimately, option 2 provides a variety of benefits but one particular benefit that I haven’t mentioned yet, is your ability to buy yourself time. Interest rates could come down either gradually or quickly much like the increases we have experienced over the last 12 months.
What is this week’s takeaway?
With bought time sort to speak, homeowners could pivot and make short term moves pushing them into a favorable credit cycle where rates come down. If rates do come down either your mortgage payment will be lower, or your one-time prepayment amount will be less.
I decided to showcase 2 options that would address rising borrowing costs but with personalized planning, clients may have more than 2 options to consider.
Have a great weekend!
Talk Soon,
Michael Zagari
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