After carefully shopping for fractional savings in mortgage rates, Canadians often end up paying more in interest than necessary because they decide to play it safe with longer terms. Since mortgage payments are made with after-tax loonies, any overpayment in interest, which is a non-deductible expense for most Canadians, is very expensive.

"Over 85 per cent of the time since 1980, mortgagors [Canadian borrowers] would have paid less in interest payments for a one-year-closed mortgage, renewing it annually, that they did by opting for a five-year term," reports Ali Manouchehri, a senior economist with Canada Mortgage and Housing Corporation (CMHC), who says borrowers use the longer terms to hedge against dramatic rate increases.

"Additional interest payments on a $100,000 mortgage with a five-year term, compared to a succession of one-year terms, averaged $2,200 annually over this period."

When it comes to mortgages, a "play it safe" strategy may be as expensive as a "just-show-me-where-to-sign" approach. Too many Canadians get swept into a mortgage full of unknowns during the frenzy of home buying. When the focus is on doing what's necessary to buy the home, often little or no attention is paid to what may happen over the years to come.

Mortgage contracts combine long-term and short-term money-management issues. Mortgages typically run 15 to 25 years into the future—the amortization period. However, some mortgage features, such as interest rate and frequency of payments, may be reviewed every few years when the term is renewed. The term may be anywhere from 6 months to more than 10 years long although most run from 1 to 5 years.

When arranging or renewing a mortgage, borrowers should ask lenders many questions about reducing mortgage costs without limiting financial flexibility. Lenders will not always volunteer this information unasked.

First-time buyers are often encouraged to take longer terms so they have time to get used to the financial responsibilities of home ownership. As the mortgage balance is paid off and home equity builds, homeowners are less vulnerable to dramatic rate hikes. Even if rates were higher on renewal, the lower balance would probably mean monthly payments would stay in the same range. With this hedge against risk, taking a more aggressive approach to reducing interest costs may net homeowners significant gains.

When renewing your mortgage, ask your mortgage lender to go through a series of computer-driven "worst-case-best-case" scenarios. Getting the facts helps you find the best way to build equity and keep mortgage interest costs to a minimum.

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Published: October 19, 1999

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