Reduce the Interest You Owe on Your Debt…
The cost of carrying a mortgage is significant. You may pay tens, probably hundreds of thousands of dollars in interest on your mortgage over the life of the mortgage.
When shopping for a mortgage, the common strategy is to hunt for the lowest interest rate. Not a bad strategy, but there is more to a mortgage than the interest rate. The interest rate is only one factor that determines how that mortgage will actually cost you. There are other factors that determine the amount of actual interest you pay.
Keeping it very simple, the amount of interest you pay is calculated by multiplying the principal you owe on your mortgage by the interest rate.
Principal x Interest Rate = Interest Owed
Interest rate is important, but so is the amount of principal you owe. If you were able to reduce the principal you owe, you reduce the interest you are charged.
Often times, mortgages allow for additional payments which lower the principal amount owed. Some take advantage of the opportunity and many don’t. Making that extra payment means less money in your bank account you would have used for other things – like paying your other bills!!
An extra $200 monthly principal payment would cut five years off the life of the mortgage and save you nearly $40,000.00 in interest.*
Most Canadians deposit their income in a chequing account. The money sits idle, earning little or no interest. If you were able to apply the money in your savings/chequing account towards your mortgage, if even for a short period of time, you would reduce your debt and thus reduce the interest you owe. Traditional bank mortgages will not let you do this. Once the additional payment is made, you can’t withdraw it for other uses later on.
If you had the choice, would you rather earn 0.25% interest that is then taxed or would you rather save 3.5% interest? A bit of a rhetorical question… Here, saving on interest is better than earning interest.
Manulife Bank offers borrowers the opportunity to put their idle cash to work by creating an account that allows you to do what other mortgages will not. They have created an account known as Manulife One that allows you to deposit your income and other savings against your mortgage, if only for short periods of time, and then withdraw the money when you need it for other purposes.
The account combines your mortgage AND your savings. As your salary is deposited into the Manulife One account, it reduces the principal on your mortgage until you start to withdraw the money you normally would to pay your bills, go out for dinner, buy groceries, etc. Because it reduces the amount you owe on your mortgage on a daily basis, your interest charges are reduced as well.
Here is an example:
A family with a mortgage of $300,000 paying 2.40% with bi-weekly payments of $750 and additional monthly household expenses of $4,000, has $500 in their savings account and earn a net monthly income of $7,000. That is $7,000 flowing through their savings account on a monthly basis, earning less than 1.0%, while they’re paying 2.40% on their debt.
|
Common Fixed Mortgage |
Manulife One |
|
| Mortgage Balance: |
$300,000 |
$300,000 |
| Interest Rate: |
3.0% |
3.5% |
| Bi-Weekly Payments: |
$750 |
$750 |
| Savings Acct Balance: |
$500 |
NA |
| Monthly Net Income: |
$7,000 |
$7,000 |
| Total Monthly Expenses: |
$5,625 |
$5,625 |
| Interest Cost: |
$101,548 |
$53,161 |
| Time to Pay Mortgage: |
20.7 years |
9.9 years |
Moving their mortgage and savings account to a Manulife One account, saves them approximately $20,000 in interest and gets them out of debt 9 years and 4 months faster, without any additional payments.
Your biggest asset is your income earning potential. By putting your biggest asset to work harder for you, the cash that would otherwise sit in a common bank account reduces the principal owed, which, in turn, reduces the amount of interest charged. (Please note, these calculations are based on rates for November 13, 2012.)
Even if you did make additional balloon payments to your traditional mortgage, you still may not receive interest savings to the same degree. Why? Because of how, or rather when, interest is often calculated in mortgages.
How Manulife One Calculates Interest
Every time you make a deposit into the account, your principal is reduced and the interest is recalculated on the new balance. This is known as simple interest. If you deposited money into the account every day, the interest would be recalculated 365 times a year, which has an immediate impact on the amount of interest owed.
How Typical Mortgage Calculates Interest
With a traditional mortgage, if you were to make an extra payment towards the mortgage, the bank will not take that additional payment into account, immediately. Typically mortgages are compounded semi-annually, which means, the interest is recalculated only twice a year instead of 365 times a year as is the case with Manulife One. Even if you make a significant balloon payment the interest calculation may not be adjusted for as much as six months.
Manulife Bank has a calculator to help you figure out if the Manulife One account will save you money or not. It is worth 5 to 10 minutes it takes to run your numbers. www.manulifeone.ca.
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You can contact Ron Malis at rmalis@monarchwealth.ca