The second most important choice you will make in purchasing your home is what kind of mortgage (if needed) you will choose.
A mortgage covers the difference between the purchase price and your down payment. The larger the down payment, the less you have to borrow, the smaller your monthly payment, and the lower your cost of interest over the term of the mortgage.
The first step towards establishing a maximum mortgage limit is to calculate a monthly payment you can afford. Financial institutions do this by calculating your debt service ratio by listing all loans (car, personal loans, monthly credit card balances). The sum of these loan payments and your mortgage payment (including principal, interest and taxes) should not exceed approximately 40% of your gross income. The mortgage payment and taxes should not exceed approximately 30% of your gross income.
The size of the mortgage you can arrange, based on payments you can afford, depends on interest rates. The lower the rates, the larger the possible mortgage and the more affordable housing is.
It is important to get a mortgage that allows you the most flexibility. An open mortgage gives you the most flexibility of all, (you can pay off any extra amount at any time without penalty), but it is also the most expensive in terms of interest rate.
You will most likely choose a conventional (closed) first mortgage. However there are a number of items you can negotiate in order to have flexibility later on when you need it.
Here are some of the things you should be sure to include:
● Negotiate the highest annual prepayment that you can. Even if you don't think you can afford it now, the time will come when you can, and you don't want to miss the benefit. The prepayment privileges on closed mortgages vary from one institution to another. The range is from 10% per year to 20%.
● Make sure you can prepay "at any given time" since you never know when excess money will be available to you and the payback is enormous over the term of the mortgage. Prepayments can be made i) at any time, ii) only at designated times and iii) on the anniversary date of the mortgage.
● Make sure you have the option to increase your monthly payments if you wish.
● Try to make your payments weekly or bi-weekly rather than monthly.*
● Keep your amortization period as short as possible .**
* It's Better To Pay Weekly or Bi-Weekly
You're ahead of the game if you can afford to pay off your mortgage on a weekly or a bi-weekly basis.
Here's an example based on a $120,000 mortgage at 8% interest, based on a 25 year amortization:
a) Monthly payment amount $915.86
Total interest cost $202,006.27
b) Bi-weekly payment amount $421.96
Total interest cost $195,561.31
c) Weekly payment amount $210.82
Total interest cost $194,326.65
** Shorten Your Amortization Period
The difference between a 15 year and a 25 year amortization period can save you a great deal of money over the long term and produce greater equity much faster. The payments are a little heavier up front, but the interest saved is enormous. If you can bear it, do it!
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