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The-Mortgage-Gal

Porting vs. new mortgage

Most people sign a five-year term when they buy a home.

You have the option of choosing either a fixed or a variable rate for your mortgage. Many opt to take a fixed rate for those five years.

People tend to choose a fixed rate because of the security of knowing what their mortgage payment will be regardless of what interest rates do during those five years.

The interest rate on a variable rate mortgage will be adjusted if prime rate changes. Lenders may handle this differently.

In some cases, your payment will be adjusted to keep your mortgage on track.

Others do not change the payments, so if interest rates rise, more of your payment goes to interest and less to principal. If interest rates drop, more of your payment goes to principal and less to interest.

Why would you choose a variable rate mortgage?

Historically, variable rate mortgages have out-performed fixed rate mortgages.

If you chose a variable rate mortgage, during the last 25 years, you would have paid off more of your mortgage than if you had chosen a fixed rate mortgage at each renewal.

In the past, variable rate mortgages were more attractive as they were priced significantly lower than fixed rate mortgages. Variable rate mortgages are priced as a factor below prime rate.

If you chose a variable rate mortgage, your documents would be worded something like this:

“The interest rate for each month shall be Lender X’s prime rate in effect on the first day of each month less .75%. Lender X’s prime rate at the date of this commitment is 2.45%. The principal and interest payment set out in this document is based on this prime rate. When the prime rate changes the principal and interest payment will be adjusted accordingly.” 

Variable rate mortgages work brilliantly in times of decreasing interest rates but can cause clients stress in times of rising interest rates.

So back to the question of why you would choose a variable rate mortgage.

Perhaps the most important reason I discuss with my clients is that should you choose to break your mortgage contract early, lenders can only charge three month’s interest as a penalty.

I worked with an online mortgage pre-payment calculator for one of Canada’s chartered banks. Assuming a current balance of $350,000, a fixed interest rate on the mortgage of 2.84%, and three years remaining in the mortgage term the penalty to pay this mortgage off early would be $20,287.

Same bank, same effective interest rate, same balance, same time remaining in the term but a variable rate mortgage and the penalty to break the mortgage early would be $2,560.

In my previous column, I talked about how not all lenders are created equal when it comes to calculating penalties for fixed rate mortgages.

When I discuss rate options with clients, despite the potentially higher penalty down the road should they choose to break the mortgage early, many clients opt for the certainty of a fixed rate mortgage.

Last week, I had conversations with several clients who are selling one home and buying another mid-way through their mortgage terms.

One client is in a variable rate mortgage and the others are in fixed rate mortgages.

The clients in fixed rate mortgages all thought they would choose to pay a penalty and take a new rate on their new mortgage until they saw what their penalties would be.

In all three cases, I ran comparisons to show them what the interest cost would be both ways (paying a penalty and taking a new rate versus taking a blended rate for the remainder of their current term).

For the fixed-rate clients, it made financial sense to port their current mortgage from their current homes to their new homes rather than paying a penalty to take advantage of today’s low rates.

For the variable rate client to port his mortgage, he had to port the exact same dollar amount and on the exact same date in order to keep his current variable rate.

In his case, this worked.

It is important to understand how your lender calculates early pre-payment penalties, and what the policies are if you want to port your mortgage sometime down the road.

If you choose a no-frills, low-rate mortgage option or a cash-back mortgage, you might be unpleasantly surprised down the road if life changes and you need to break your mortgage contract.

When you are sitting down with your mortgage professional, it is important to consider what potentially change in your life over the next five years.

Is this a starter home for you and you will most likely be starting a family and looking for a bigger home?

Are you on a career path that may include a move to another city?

Answers to these questions may help guide your decision regarding choosing a fixed versus variable rate mortgage.

This rate decision will play into whether you break your mortgage and choose a new rate or choose to port your mortgage to a new property should you sell your current home down the road.



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Escalating penalties

One discussion I have with my clients upfront is whether they want to choose a fixed rate or a variable rate.

Most of my clients opt for a fixed rate mortgage because they want the security of knowing what their mortgage payment will be in case rates go up.

Why would someone choose a variable rate mortgage?

The most important consideration is pre-payment calculations.

If you choose a variable rate mortgage, the maximum penalty your lender can charge should you choose to pay the mortgage in full at any point before your scheduled maturity date is three month’s interest.

If you choose a fixed rate mortgage, you are looking at the greater of three months’ interest on the balance you currently owe or the interest rate differential (IRD).

What is the IRD? Here is the definition from the Financial Consumer Agency of Canada’s website.

The interest rate differential is the difference between the interest rate on your current mortgage term and today’s interest rate for a term that is the same length as the remaining time left on your current term.

Why is the penalty calculation important and when does it come in to play?

The penalty calculation is important when you need to break your mortgage prior to your maturity date. All mortgages are not created equal when it comes to paying in full ahead of schedule.

When I talk about “breaking” your mortgage, I mean paying it out in full before the end of your mortgage term.

Why would you break your mortgage before the maturity date?

Some of the common reasons we see are:

  • Change in financial situation / financial hardship so forced to sell your home
  • Change in marital status / neither keeping the home
  • Moving and choosing not to buy in the new location
  • Refinance to renovate or consolidate debts
  • Switch to a different lender for lower rates
  • Selling and purchasing a new home of a type that your current lender won’t consider (i.e.: log home, rural property, remote location)

Using the exact same information for each lender, I went to their online prepayment calculators to see what their prepayment penalties would be. Assuming:

  • A current mortgage balance of $400,000
  • Contract interest rate of 3.04%
  • Maturity date of Aug. 4, 2023
  • Current rate for a similar term of 2.09%

It is interesting to see how the penalties vary from one lender to another.

Lender                       Fixed Penalty                   Variable Penalty

First National             $7,272.30.                         $3,040

RFA/Street Capital    $8,464.65                          $3,040

RBC                            $14,141.70                        $3,040

TD                               $18,315.83                        $3,040

My point in sharing this is not in any way to slam a particular lender. I often place clients with TD. They have great products and will look at applications that other lenders may not.

As rates have plummeted over the last few months, we have seen many lenders drop their rates for their one to four year mortgage terms.

This effectively increases your penalty if you are breaking your term early. In some cases I’ve heard about this has doubled or even tripled the mortgage penalty from the time people started the process of refinancing or selling their home but moving to a different lender with their purchase.

One of my clients was provided an estimate of his penalty which was $1,900. Estimates always come with the qualifier that this amount is subject to change depending on any changes to interest rates.

When his house sold six weeks later, he was not happy to learn that his penalty had climbed to $9,967 due to the drop in interest rates in the meantime.

The saving grace for this client was that he had significant equity in his home to the added $8,000 did not leave him short for the down payment on his new home.

Added bonus is that the rate on his purchase has also dropped form 2.34% to 1.99%, so he will save far more than the $8000 over the next five years.

When you are wrapped up in the excitement of buying a new home, the last thing you are thinking about is having to break your mortgage early.

Pre-payment penalties should be a conversation you have with your mortgage person.

If you are part way through the process of buying and selling a home or waiting for a switch or refinance to close, double check your penalty to make sure it does not affect your new mortgage.



Stress Test dropping

This has been a busy week in the mortgage world.

There were rumblings that the Stress Test was going to be reduced and Evan Siddall, head of Canada Mortgage and Housing Corporation (CMHC), released a three-page document that prompted much debate and feedback.

Normally, when I sit down to write, my column it flows. Today, I am struggling.

I am not an economist. Helping clients buy homes is my bread and butter, so there is no way I can be completely objective with my thoughts about Siddall’s document.

Earlier this year CMHC announced changes to its underwriting criteria. In a previous column, I wrote about what those changes were.

The document that was shared this week was a letter to CMHC Approved Lenders encouraging them to adopt more stringent lending criteria.

While the intent of the recommendations is to prevent Canadians from becoming over-extended, I think we are potentially taking the wrong approach here.

I’ve said repeatedly that while reviewing applications, it is not the mortgage commitment that gets clients into financial hot water but other loans and credit card balances.

To be approved for a mortgage, clients go through a rigorous application process and must produce a multitude of documents to help confirm their credit worthiness.

Ask anyone who has recently been down this road and they will tell you how much fun this is.

On the other hand, they can walk into a car dealership or furniture store and be approved for credit within minutes.

One of my concerns about further tightening mortgage guidelines is the effect it has on buyers trying to enter the housing market.

I am frustrated when I see families that I sense will never miss a mortgage payment unable to qualify to buy a home.

I am working with a young couple that makes $90,000 a year between them. They are conscientious savers and limited credit seekers.

They do have a small car payment, but otherwise pay their credit cards monthly and add to their savings each payday. Their credit is squeaky clean.

An annual family income of $90,000 is not chump change.

They will not be able to afford a single-family home in their city. They are having difficulty finding a condo in their price range in their market.

To buy a two-bedroom condo, they have set a price point of about $375,000. With their mortgage payment, strata payment, and property taxes they are looking at a commitment of about $1,950 a month.

Their current rent payment for a similar unit is $2,400 a month.

Based on their application, they are qualified to purchase a home with a price up to about $425,000, but they have decided on a monthly amount they are comfortable paying and don’t want to go any higher than the $375,000 price I started with.

Their approach is not unique. Many of my clients choose a price point based on what they are comfortable paying monthly as opposed to what they are qualified to borrow.

Today, the Stress Test drops to 4.79% from 4.94%.

What does this mean in terms of increased borrowing power?

For this young couple, it means an increase of approximately $10,000 if what they are qualified to borrow. It may not sound like much, but for some clients it will make a difference.

I went off on a bit of a tangent there, but circling back my point is that I don’t feel that making it more challenging for Canadians to buy a home is the right approach.

Should everyone be able to own a home? Buying a home in Canada is a privilege, not a right. Continually moving the goal post and making it harder for people to buy a home benefits landlords and drives people to try to circumvent the rules.

Prudent mortgage lending guidelines are important, no question. No one wants to see people defaulting on their mortgage payments because they are in over their heads.

It is important to note that there are two other companies that provide mortgage default insurance.  

Neither of these companies have chosen to follow CMHC’s lead, and it will be interesting to see what happens long term.





Time for a better rate?

Mortgage interest rates have continued to drop during the last few weeks.

I’ve had many calls from clients wondering if it is worthwhile to break their current mortgages and re-do them into today’s lower rates.

The straight answer is it all depends. It depends on:

  • Where you are in your current mortgage term (how much time is left until your maturity date)\
  • What your current interest rate is
  • Which lender you are with
  • Whether you are in a fixed or variable rate

Most lenders have prepayment penalty calculators online. It is fairly straightforward to calculate what your penalty might be.

If your mortgage is with a chartered bank, you will need to know the “discount” they gave you off their posted rate when you originally signed your mortgage.

Often that discount is around two per cent, and you should be able to see it on one of your annual mortgage statements.

Incidentally, this discount is one of the reasons that I love to work with monoline lenders. Monoline lenders are companies that just do mortgages. They calculate their prepayment penalties by comparing your rate to the best rate currently available.

This is a small piece of the puzzle for choosing the right lender, but what it means is (generally) a prepayment penalty that is considerably smaller. If you are considering mortgage options, this is an important piece to understand.

So back to whether now is the time to re-do your mortgage.

If you calculate your penalty and it seems reasonable, the next step is to compare how much the penalty is to the difference in interest cost between your current mortgage and what the cost would be if you re-did your mortgage.

If there is a cost savings, it might be wise to re-do your mortgage now.

If there isn’t much of a savings, but you want the security of a low rate for another five years, you may want to re-do you mortgage.

I run these calculations daily lately. I don’t like to see people pay the penalty (which usually equates to interest for the remainder of their current term) unless there is a significant interest savings.

Other factors do come in to play.

Some people want to roll existing consumer debt in with their mortgage and are less concerned about the penalty.

Some people are in variable rate mortgages so their prepayment penalty would only be three months’ interest.

If you are wondering how the numbers look for you, we are happy to crunch them for you.

Re-doing your mortgage is either an early renewal or a refinance, depending on whether you choose to add additional money to your mortgage or not. Before you make the decision either way, its important to do your homework and understand the process.

For a quick overview of what to think about, check out our blog Mortgage Renewal Homework.

Lenders are very competitive right now, and I’ve seen some interesting promo rates and packages.

One of the interesting packages I’ve seen is an “Interest Free for Three.” The lender covers the interest for the first three months of your mortgage to help free up cash flow during these uncertain times.

Here’s an example of how it works. With a $325,000 mortgage at a 2.24% five-year fixed rate and 25-year amortization, the regular payments would be: $1,415.82.

For the first 90 days of the new mortgage, the lender will cover the interest and you save the difference.

Interest portion paid by the lender:

  • Month One: $606.67
  • Month Two: $605.16
  • Month Three: $603.64

Total savings for you: $1,815.47 — For illustration purposes only, based on monthly payments. Rates are subject to change at any time without notice.

You keep these cost savings in your pocket to provide some relief during these times or use them to improve your financial situation later. For example, you could:

  • Use the savings to manage other debts that are less flexible
  • Use it toward other purchases instead of using credit
  • Apply the savings as a lump sum payment against your mortgage after the three months are up, save additional interest costs and reduce your amortization by an extra two months

The mortgage is priced .05 per cent higher than their regular product, but running the numbers shows that with the three months’ interest covered you actually save a bit as compared to the lower rate.

For first time home buyers starting out, this might be a great option. Moving into a new home comes with some unexpected expenses.

Re-doing your mortgage to a lower rate may mean cost savings and lower monthly payments. We’re happy to help you compare the numbers to see if this is the right decision for you.

Enjoy B.C. Day!



More The Mortgage Gal articles

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About the Author

Tracy Head and Laurie Baird help busy families find mortgage solutions. Together they have more than 45 years of experience in the mortgage industry.

With today’s increasingly complicated mortgage rules, Tracy and Laurie spend time getting to know the people they work with and help them to better understand the mortgage process. They support their clients before, during, and after their mortgage is in place.

Tracy and Laurie work closely with their clients, offering advice and options. With access to more than 40 different lenders, Tracy and Laurie are able to assist with residential, commercial, and reverse mortgages in order to match the needs of their clients with the right mortgage package.

They work closely with their clients to find the right fit, and are around to provide support for years down the road!

Contact them at 250-862-1806 or visit http://www.okanaganmortgages.com

Visit their blog at https://www.okanaganmortgages.com/blog

 



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The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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