The opportunity to downsize is an exciting one. Think about it: less cleaning, less maintenance and, let's not forget, the many financial benefits. But downsizing doesn’t simply mean packing up the old family home. There’s a mortgage that goes with it and there are a few key decisions that need to be made along the way.
So, before you move into your urban townhome or cozy condo building, don’t forget to consider your downsizing options, especially when it comes to your mortgage.
The Big Decision
Likely the biggest decision you'll need to make as you prepare to transition is whether you port your mortgage or re-negotiate. Before diving into the pros and cons lets go over the basics.
To port your mortgage means to transfer your current balance at the present interest rate from your old house to your new house. Porting your mortgage permits you to maintain your current mortgage and interest rate and, if necessary, add an additional mortgage payment at today’s interest rate. If mortgage rates are higher now than they were when you secured your first mortgage, a blended rate comes into the equation, as an alternative to renegotiating.
To re-negotiate means exactly what you think it does. Going back to the drawing board and constructing a new mortgage, at a new negotiated rate.
Port Your Mortgage
So what are the benefits and drawbacks to porting your mortgage? There are a couple specific scenarios where doing so can be beneficial.
First, if your current mortgage rate is lower than the ones being offered on the market, porting your mortgage can make a lot of sense. In this case, you can transfer a more favourable rate over to your new property. Plain and simple.
Another reason for this option is if you need to borrow more money from the bank, thus adding to your mortgage. In this scenario porting your mortgage would permit you to maintain your favourable rate on the majority of your mortgage while applying a new rate to the additional amount borrowed. If you’d prefer to combine your mortgages, you can acquire a blended interest rate on a restructured mortgage. Blended rates, the combination of your old and new interest rate, are also usually lower than a newly negotiated rate.
So when is porting your mortgage undesirable? Typically, if you're downsizing and require less money than your initial mortgage provides, or if interest rates are significantly lower than when you secured your first mortgage. In these instances, it may make more sense to re-negotiate.
Time To Renegotiate
In order to re-negotiate your mortgage, you're required to break your initial contract. Doing so forces you to take on a penalty – typically a three-month penalty – so it’s important to weigh your prospective savings over time against a three-month penalty.
Re-negotiating your mortgage makes sense if you're downsizing in mortgage size as well. Unless your new mortgage rate is going to be significantly higher than your old one it might be worth taking on the three-month penalty to re-negotiate for a smaller mortgage and more savings over time. When looking at new rates, it really comes down to a simple equation of savings over time versus the cost of breaking your contract.
Fixed Or Variable
A secondary but no less important question when considering downsizing your mortgage is whether or not you take on a fixed or variable mortgage rate.
In simple terms, a variable rate mortgage means the interest rate can change constantly and as a result, your mortgage payment can also change. By contrast, a fixed rate mortgage enables a buyer to lock into an interest rate for a set amount of time – usually in the ballpark of one to five years.
Fixed mortgage rates are certainly the most common selection, but not for the reason you might expect. Fixed mortgage rates are often locked in for reasons of security and peace of mind. With the seemingly on-going concern that interest rates could rise, a fixed rate may come at a higher cost than a variable rate, but it protects you against rising interest rates. It’s not necessarily a bad choice, but it may not always be the most rational either. Let’s look at variable rates to see why.
When it comes to variable rates, your mortgage payment is likely to fluctuate over time as interest rates change. So while variable rates are typically lower than fixed rates, many shy away from taking on variable rates due to the fear of rising costs. While this fear is certainly granted, in times of low-interest rates and relative stability, a variable rate isn’t a bad option to consider.
Variable rates really become appealing when the margin between fixed rates and variable rates is relatively high. Typically, the longer the fixed rate, the higher the interest rate. If the spread is quite low, however, a slightly higher mortgage rate may be well worth the security of locking in.
Be Wise When You Downsize
There’s a lot to consider when downsizing your mortgage, but it doesn’t need to be overwhelming. Some of your decision will naturally be determined by present-day interest rates and future forecasts. In addition, if you're unsure about how to lower your costs when downsizing, a brief chat with a financial advisor should make the way forward pretty clear. While the decision-making process is largely context driven, it’s worth being strategic about. In the end, it could be the difference between thousands in your pocket.