Cash Flow and Mortgage Payments

These days, many of us are grappling with reduced cash flow, primarily because of escalating prices (inflation), compounded by increasing mortgage payments.  The increase in the Banak of Canada Prime rate over the past 20 months, aimed at tackling rising inflation, has left numerous Canadians cash-strapped until the anticipated lowering of the Prime rate in 2024.

For homeowners with mortgages, one of the keys to addressing the challenges of daily cash flow lies in understanding amortization – the timeframe for repaying the mortgage in full.

When first getting a mortgage, most people opt for a 25 or (if available) 30 year amortization.  As you make payments, you amortization naturally shortens. It is inversely proportional to mortgage payments: longer amortization equals lower payments, and shorter amortization results in higher payments.

People who have variable rate mortgages are especially affected by the increase in Prime rate and pressure on their monthly cash flow. From March 2022 to July 2023, the Canadian Prime rate increased from 2.7% to 7.2% – tripling interest costs and in some cases, even doubling mortgage payments.

And people who have fixed rate mortgages that expire during this high Prime rate phase are also significantly impacted – as they face increased rates at renewal – often going from around 3% to over 6%, and even as high as 7%.

For people entering the real estate market, increasingly high rates will influence how much they can spend on a home, adding an addition layer to the financial challenges of home ownership.

So, what can be done?

If you’re struggling with making your mortgage payments, there are still some steps you can take to ease the burden.  If you have a variable rate mortgage, you can talk to us (your friendly mortgage broker) or directly with your bank.  Ask them to extend your amortization and in turn lower your payments. Same applies to holders of fixed rates whose mortgages are up for renewal.

You may be able to lower your monthly payments (at no additional administrative cost), especially if you have been making extra payments towards your mortgage over the years. For example, if you originally selected a 25 years amortization and 5 years have passed, you should have 20 years remaining. If, during that time, you were making lump sum payments, you could be, for example, pacing at 13 years amortization. Your bank should be able to increase your amortization back to 20 years without having to register a new “charge” against the property and in such way avoid legal fees.

In the event that you haven’t been making increased or lump sum payments – you amortization after 5 years would be 20 years. In this scenario, the only way to lower your payments through amortization would be to request that the bank increase your amortization back to 25 or 30 years. To do this, the bank would have to register a new charge on your mortgage, which carries legal fees of around $900. In this case, the cost may not be worth the benefit to you.  If however, the amortization on your original mortgage was short (like 10 years), the impact to your monthly payment of going back to a 25 or 30 year amortization may be meaningful to your monthly cash flow and worth the $900 legal fees.

It’s important to remember that the current high-interest rate situation is temporary. When rates eventually decrease, payments can be increased and the amortization shortened again.

For those with existing mortgages, but that also have high credit card debt, reconsidering mortgage payments and opting for longer amortization could provide a comfortable cash flow, especially considering the high-interest rates associated with credit card debt.

For new buyers entering the market, we recommend starting with the longest possible amortization, 30 years if available.  While this may come with a slight rate premium, it provides flexibility with lowering mortgage payments during high rate periods, and a sense of insurance in times of your own personal cash flows challenges.

Finally, amortization is a powerful tool to help you manage your mortgage.  Remember that the original amortization you chose at the beginning of your mortgage is less impactful that the amortization you manage during the life of your mortgage. Using prepayment options allows you to control amortization by increasing or decreasing payments and allocating extra funds against the mortgage.

We’re indeed in a challenging interest rate environment. And while we fully expect rates to decrease in the spring/summer of 2024 – we don’t believe they will ever go down to the 1% variable and 2% fixed rates we saw during the pandemic.

In the meantime, when adapting to changing rates, we can always use the tools available to us to help ease us through transitions.

Photo by Towfiqu Barbhuiya on Unsplash