Quote:
Originally Posted by Geraldsh
My son is shopping for a mortgage and asked for a 5 year fixed rate. The bank advised him to limit the fixed term to 2 years - what would you advise?
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This is not the best of advice to maximize savings... but a balanced approach for education vs aiming for the best rate for your son might be important as well.
Be very careful in separating the concepts overall cash flow vs income vs expenses. The entirety of a mortgage is not an expense. A portion is forced savings. You'd be surprised how many people seriously do not understand this concept and some of which I've met have more than a million in net worth.
How financially savvy is he? For a first mortgage or not too financially savvy, 2-3 year fixed to understand how it works but also to lock in steady "expenses" is a good thing to do while learning how things work. Have your son sit down with an advisor and listen to the whole schpiel they make about how to make a decision. Then have a discussion together and also do some research as well. Advisors are good, but sometimes they don't have the entire big picture. Their advice might be good and make sense short term, but not necessarily long term.
It might cost him extra money up front, but it's something IMO important to learn the break down of principal payment and interest without then having to figure out other stuff relating to variable. Otherwise, it'll almost always be, "Which should I choose?" without knowing the reason why it's one or the other and whether the answer could switch based on changes in market circumstances. Yes, I get that variable is sorta like that, but with more fluctuations in interest/principle split, it gets too complicated at younger individuals don't learn about it until it's too late.
I also tried teaching others about the concept of how much you're giving to the bank. It does help to realize that if you have a $300K mortgage at like $5%, that's $15K to the bank in "convenience fees" PER YEAR. If you expect to pay down a mortgage in 10 or 20 years, if you do that calculation (simple, ignoring compound), suddenly you realize why people used to celebrate mortgage free. It's cash flow unlocking AND yearly savings.
This vs 2% savings on $50k is $1K per year or $250 per 3 months, paying down the mortgage at 3% right now isn't the greatest of ideas. Too much opportunity cost given up based on current rates and current potential cash flow needs for the next 2-3 years. I'm better off putting it into bank stocks and/or short term GICs and then taking some 0% financing offers on some house repairs and upgrades and earning a little bit on those rather than paying any debt I have immediately as I used to do.
I know some people who love sitting on cash because they're ultra risk averse. Like, 60-90K of cash as the rainy day fund sort of thing. After explaining it this way and explaining stocks such as growing at X% less taxes vs saving percentages on mortgages, LOC and credit cards vs spreads on earning/growth vs immediate savings and risk tolerance, things have improved substantially in her financial literacy. For GICs though, I would advise making sure the duration that are purchased are appropriate (ie: 30, 60, 90, 1 year etc.) for what your needs are. My wife thought I was BSing her when I said we were accumulating net worth faster than both our parents and would likely surpass them by age 40. This not including the fact I bought a whole life insurance plan in my 20s and it'll be paid off soon and will just accumulate a cash balance/net value for me for the rest of my life.
But when I explained how we got into investing earlier than they did by decades (vs parents sat on cash and only started investing in their 40s and 50s) and how housing prices are now benefiting us more than them, or the fact our parents don't know how to leverage assets as much, it made sense to her.
I'm not joking when I say some people are seriously weird in their financial literacy logic, and I'd be lying if I didn't say I have also grown substantially in my personal understanding in the last few years as well.
Like people who literally know the logic inside and out, but refuse to do the calculations. Once they do the calculations, they realize they've been really screwing things up with rule of thumbs that they've been using.
Personally, I used to hate borrowing money. Now I realize that there's some free cash here and there for borrowing. Also, doing the real calculation of interest on certain loans vs the mental anguish on a number that I never calculate that turns out to be like saving $500 a year but losing a flexibility that I'd easily pay double that for for an extra 6-8 months to pay it off/not have to delay vacations, take advantage of deals etc. But I also realized it makes sense to look at time lines for 1, 3, 5 and 10 years.
It's a new and important lesson IMO that I'm personally learning how to balance militant saving/pay down behaviours vs paying interest on purpose. I'm glad I can be learning and discussing these topics in real time with the spouse. I'm still bummed that I won't be mortgage free by 40, but after doing the calculations, I'm more comfortable deferring that by around 3-5 years and then basking in the savings and the fact I'll basically have no more major costs from that point on.
Basically from age 40-60, we'll be doing damn well with expected ability to save making a huge spike, but the next few years before I hit 40, we need to be a little bit lean for cash flow purposes. At 60 onwards, we might hit large housing expenses again, but at that point we wonder if we'll be moving from this house, or if we bite the bullet and defer mortgage free another year or two with upgrades that would allow us to kick the can down the road for revisiting another 10-20 years etc.