Ed note. Real Life is a periodic feature detailing stories about the situations HomeBuyers encounter in the real world.
A reader sent me an excellent question in response to a previous post about 40-year amortization mortgages. I believe that Nick's concern is something that many of us can identify with, so I am featuring both his question and my answer in today's post:
My wife and I purchased our home a couple of years ago. Since then, increases in mortgage amortization limits and our salaries mean that we can afford our dream home today. The home we really want is close to our existing neighbourhood but significantly more spacious. Our current home is a good size and is comfortable, but we are worried that if we don’t buy the more expensive home today, it will be out of reach in the future. My question is, should we stay in our current home, try to pay off our mortgage faster and hope that the home we really want stays within our reach or should we just make the plunge and buy our dream home today?
You ask a very good question. Many HomeBuyers often worry that the home they want to buy will be out of reach in the future. While this concern is an important one for first-time HomeBuyers, it is less of a concern for someone who is already on the property ladder.
Your dream home may appreciate in value over the next five to ten years, but this won't necessarily leave it out of reach. Don’t forget that if your dream home is increasing in value, it’s likely that your current home will also appreciate at a similar rate. The value of each of the homes may change at different rates over time, but their value relative to one another should remain fairly close. Now, if the two homes in question differ greatly when it comes to style (condo vs. freehold house) or location, their values relative to one another may fluctuate more over time. But because your current home is similar in style and location to your dream home, you shouldn’t worry too much about it being out of reach tomorrow. It’s probably going to be just as out of reach tomorrow as it is today.
Having said that, there is no right or wrong answer to your question. It’s all a matter of personal preference. For some people,it makes sense to stretch out mortgage payments over 40 years and pay more interest if it means living in a dream home today. For others, it makes more sense to go for a shorter-term mortgage and focus on paying off the mortgage principal faster. Personally, I like the latter approach.
Over the long-term, you will be in a much stronger financial position if you focus on paying off your current mortgage faster. In ten years' time, you will have more equity saved up in your current home than you would have had if you had moved to your dream home. Why? Well, by taking out a longer mortgage term to pay for the more expensive home, you put more of your monthly payment towards paying off the extra interest you owe instead of paying down your principal.
Here are a couple of tips on paying down your current mortgage even faster:
1) Make sure your mortgage payments are on an accelerated bi-weekly (every 14 days) schedule. This is different from regular bi-weekly, which is paid twice a month. Accelerated bi-weekly means that you make two more mortgage payments a year, taking years off the life of your mortgage.
2) Don’t count on making that allowable lump sum payment to get ahead at the end of each year - this rarely happens. Plan to increase your mortgage payments by 5% each year instead. If your bi-weekly mortgage payment was $500 last year, increase it to $525 this year, then increase it another 5% the following year, and so on. If 5% is too much or too little, adjust this amount according to your own personal budget.
Assuming that both you and your wife are happy living in your current home, you should focus on paying off your existing mortgage faster. You’ll find yourself in a much stronger financial position when it comes time to move on to bigger or better things.