Mortgage rates are important and most clients want to talk about rates. What many clients don’t realize is that while comparing mortgage rates is important, pre-payment options and those nasty penalty calculations are essential to avoiding buyer’s remorse.
Choosing the right lender for your fixed rate mortgage needs your attention!
Canada’s 6 biggest banks have the highest calculated penalties if you need to break the mortgage (around 4% of the mortgage balance).
We have many lenders with better pre-payment features, same (or better rates) and a penalty that is around 2% of the mortgage balance!
Although it’s hard to imagine the need to break a mortgage on a house you’re just buying or living in happily, it can happen.
History tells us that close to 63% of home owners will get out of their 5 year mortgage after about 3 years for various reasons.
Many do it to refinance for debt consolidation or to renovate, help their children, buy a vacation property, or many other reasons.
Sometimes the need is to move to a bigger house or to get a new lower rate! We don’t want your penalty to get in the way of your next decision.
Mortgage penalties are straightforward if you have a variable-rate mortgage. Expect to pay the equivalent of three months’ interest in most cases, which is the best out of all penalty scenarios.
With a fixed-rate mortgage, the penalty is set at the higher of three months’ interest or a calculation called the interest rate differential (IRD).
IRD is basically the difference in the rate between what you originally got and what the rate is today (based on the number of years remaining in your mortgage term) multiplied by the number of months remaining in your term. It’s confusing we know.
Think of it from the bank’s point of view. They’re losing out on interest that they thought they were going to get so if you want to get out early and the rates are lower than what you originally signed up for, then the bank is losing out on that extra interest and will charge you for it.
The must-ask question when we are negotiating a fixed-rate mortgage for you: Do you use discounted or posted rates to calculate these penalties?
This is important because using posted rates can result in a much higher penalty. As an example, let’s use the mortgage prepayment calculators that all lenders now provide on their websites. They show penalties for paying all or a portion of your remaining mortgage balance (to find them, search the net for your lender’s name and “mortgage prepayment calculator”).
Let’s use an example of someone who, 2 years ago, set up a $650,000 five-year mortgage and has a balance owning of $500,000. Assuming an original mortgage rate of 3.29 per cent with a discount of 1.75 percentage points, the mortgage prepayment calculators at several big banks showed penalties ranging from $28,000 to $32,600 or so.
A check with some monoline lenders (companies that just do mortgages) found penalties ranging from $11,600 to $15,800. These are estimated comparisons because lenders ask for different information on their web sites, however, the big banks apply penalties with a sledgehammer.
These penalties create huge revenues for the banks. The huge mortgage penalties also help trap clients who might otherwise move their business to another lender. Imagine you want to refinance your mortgage or buy a bigger home and your bank doesn’t offer you the most competitive rate. You say that you’ll change banks, only to find out how prohibitively expensive it is to break your mortgage.
So we know you’re asking yourself “How did I not know about these penalty calculations before?” It’s because the banks don’t like to talk about it and they hope that you stay with them because you’re familiar and comfortable with them, even though they can wind up costing you thousands and thousands of extra dollars, should you have to break your mortgage for whatever reason. It’s our job to go over all of this with you and to help guide you to the right decision.
Now don’t get us wrong, we do like banks and send many clients there who are best served by them. We just want you (the consumer) to be fully informed of the penalty differences as that’s something that rarely gets discussed.
Courtesy of Jam Mortgages. Please visit our website for more great info.