Monday, October 17, 2011

Don’t Let Loans and Mortgages Stress You Out


Don’t Let Loans and Mortgages Stress You Out

As an insurance advisor and financial planner, I meet many people, plenty of whom let me peek at their income and expenses and ask me for improvement ideas. Over the years, I started recognizing certain patterns in the way we earn and spend. I would like to share with you my list of financial savers people overlook, and I explain how easy it is to make them work in your favour.
It’s important to note that you don’t have to exert significant mental effort to “adhere to a financial diet.” My advice will help you make the right decisions ahead of time so that you can benefit from it without keeping it in mind forever.
Today, my tips relate to mortgages. If you like them, I’ll be happy to bring you my insurance tips as well. I am, after all, predominantly an insurance broker.

Mortgage Compounding

When you’re shopping for a mortgage, make sure that you know how often your principal is compounded. Some lenders compound semi-annually and some compound monthly. The higher the frequency of compounding, the higher the total interest you pay.
Although you would think that the difference is minimal, different compounding schedules can amount to a significant sum over the lifetime of a mortgage or another large, long-term loan.
Learn more about the effect of interest rate compounding here.

Mortgage/Loan Prepayment

Loan prepayment is essentially sending more money to the lender than they ask for (per month). You know that every instalment that you pay back consists of an interest portion and a principal portion. It’s only the principal portion that actually decreases your indebtedness. If you pay back more than you have to, this amount will be discounted from the principal.
As you probably anticipate at this point, decreasing your principal results in a (slightly) decreased interest. Decreased interest in turn means that your next instalment will offset more principal and will thus speed up the complete repayment of your loan. This is how you can make the complexities of loan repayment work in your favour.
Because of the mechanics of loans (and mortgages are also a form of secured loan), prepaying at the beginning of the loan’s lifetime has an exponentially larger effect on the total cost of your loan than accelerating your payments at the end of the loan’s lifetime.
The effectiveness of early prepayments in turn suggests that any time you have excess cash, you should put it into the freshest loan you have (or alternatively to the loan with the highest interest rate), as opposed to trying to finish off an old loan that’s almost paid up. I know it feels good to kill off a liability like this, but trust me: it feels much better to save plenty of money by virtue of a simple decision instead.
Of course, you need to make sure that prepayment is an option with your lender. Some lenders may charge you a penalty if you try to prepay your loans. Yes, it is a rather silly practice, but it’s stipulated in many credit agreements. Make sure to check whether prepayment is an option with your lender and shop around for a contract that does allow you to prepay if you can.
Learn more about prepaying your mortgage effectively here.

Use Extended Amortization to Ensure Mortgage Approval

This is a handy trick that works in Canada. Please let us know in the comments if it works elsewhere as well!
In some cases, you may want to take out your mortgage with an extended amortization period. This means that your term will be more than 30 years; in fact, it can be up to 40 years. In order to qualify for an extended amortization, you have to be able to provide more than 20% down payment on the property that you’re buying. If you can do that, read on.
If you spread out your instalments across a longer period, you’ll effectively pay less each month, thus freeing up some of your cash flow. What’s more, the lower resulting monthly payments may help you to qualify for a higher loan amount in the first place.
This means that if you apply for an extended amortization mortgage, you can apply for higher face amounts, and you increase the likelihood of approval. And higher mortgage face amounts mean better and larger houses.
And now comes the best part: after you’ve been approved for the prolonged amortization, you can set your payment schedule up shorter so that your mortgage will in fact only last for 30 years (or less).
If you shorten your schedule, you will of course have to pay higher monthly premiums, but you will also be saving substantially on interest and will be done with your mortgage sooner. This is, by the way, a brilliant way of applying the principle of Loan Prepayment that I described above.
If you want to make use of this trick, you should be confident that you’ll maintain the income necessary to support this accelerated schedule. The good news is, however, that you can always return to the extended period later if need be.

Read more on extended amortization in Canada here.

This article was brought to you by Lorne S. Marr, an independent life insurance broker from Toronto, Canada. Lorne has been in the life insurance business for almost 19 years and is sure he can help you get the best deal no matter what your medical history.

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