Payment Engineering

When buying a home one should keep focused on the actual price as opposed to the payments. This is especially true today with all the ways the they can be made to appear lower in advertisements. Consider this builder ad I found in the "Homes" section of the Edmonton Journal.



$611 bi-weekly? In the example below I will start with a fairly normal mortgage and work towards this engineered payments of $611. This will highlight how much impact different choices can have on the appearance of financing costs.

The listed price is $383,800. With a 10% down payment, 2% of that would go to CMHC fees and the total mortgage amount would be $353,096. Assume a 25 year amortization, 10% down and a 5 year fixed rate of 4.5% the mortgage payments would be $1,954.30/month

This does not include property taxes typically rolled into the mortgage payment. I would not expect a builder to include this but it is useful to note among other things when comparing to rent. These payments are for the first 5 years only, the remaining 20 will be paid back at a different rate. For example if interest rates are 7% during the last 20 years of the mortgage the monthly payments for that time period would be $2,384.91.

How do we get to $611?

1. Bi-weekly payments

Bi-weekly is a clever way of showing payments because initially people think of it as pretty much two payments a month. However on average throughout the year it is actually 2.17 payments per month. $1954.30/month works out to $977.15 semi-monthly and $901.99 bi-weekly.

2. 35-year amortization

Bi-weekly payments are reduced from $901.99 to $767.06 when the amortization is increased by 10 years. No free lunch here as in the end the longer amortization costs a lot more in total interest.

3. Downpayment

This example started with a 10% down payment but this ad used a 20% down, or $76,760. A buyer enticed by low bi-weekly payments over 35-years probably would not be putting down that much which is why I picked 10% for this example. Using a 20% downpayment reduced the payment to $667.01.

4. Interest rate

There was no mention of the interest rate but clearly they are using less than 4.5%. With a 3.84% rate instead I arrive at payments of $611. This rate is now only available with a shorter term, probably 3 years, which neglects the remaining 32 years of financing at unknown (higher) rates.

All the above serve to reduce the payment shown but each carries some risk or cost. No matter how the debt repayment is structured buyers are on the hook for the purchase price.

Update: This ad has been updated with payments of $599. They must have lowered the interest rate used in their calculations.