Sunday 6th August, 2006


Take out your mortgage when rates are lower

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A spate of advertisements in the local print media has made it clear that prime lending rates are going up. So what exactly is this prime rate?

What is commonly called the prime rate is a benchmark interest rate for loans pegged to the rate at which banks borrow money. Mortgage rates tend to be higher than the prime lending rate, because banks make money from lending money. They therefore charge the consumer more than they have to pay for money.

If the interest rate is going up, then the banks are paying more for money. It would follow then that investors can expect a higher rate of return on deposits, bonds etc. So, mortgage rates will be higher than bond rates. Remember too that inflation tends to follow interest rates.

Remember as well, that classically the term “mortgage” refers to the agreement that gives the lender the right to take possession of your property if you fail to make the requisite payments.

Now, when interest rates are going up, is it the best time to afford a mortgage loan? I think not! The best time is when rates are low or dropping. But other things must be considered too!

Debt to income ratio, is the amount of money you owe in relation to the amount you earn. If that ratio is too high, that is not good. So reduce your debt before you apply for a mortgage.

If you can afford to pay a mortgage instalment of $3,000 per month, and the rate is 14 per cent per annum, and if you are prepared to pay for 30 years, you will qualify for about $350,000.

In addition to repaying the interest and principal, mortgage expense computations include the rates and taxes that are payable annually on the property, as well as the cost of property insurance.

A common error on the part of homeowners is that they purchase insurance just enough to cover the mortgage loan. This is commonly the stipulation of the lender. However, the home cost includes the deposit, plus significant small sums of cash that come out of discretionary

every month.

It follows then that if the property will cost $500,000, you may borrow only $450,000, and take out only $450,000 in insurance. Apart from that, the contents of the home need to be covered, under a separate policy.

It will appear then that an appropriate insurance cover for such a property may be closer to $600,000 with a contents policy in the vicinity of $70,000.

The truth is that, once the homeowner moves into his new property, there will be substantial purchases over the next five years, as the drapery rods, the shower fixtures, and the light fixtures are upgraded.

Then too, there are landscaping costs, and fencing which could be as much as $50,000, in the first instance.

There are few varieties of mortgages. The common type is the fixed rate mortgage. This requires a fixed payment for the duration. There is another variety called an adjustable rate or a fixed/adjustable hybrid; another variety requires interest payments only, in the first five years generally.

The common fixed rate mortgage is the most user-friendly and the least strenuous. Consumers can be deceived by the apparent ease of payments within other types. Remember that although salaries do increase over the years, household expenses and inflation also increase, and the ability to pay a higher instalment in later years, may not be realised.

In final analysis, what you can afford to do in your new home rests on a sliding scale, intricately tied in with the new prime lending rates.


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