Posted in Applying for a mortgage - Lisa Alentejano services the interior, BC Mortgages, Best Rate Mortgages, British Columbia Mortgages, Canadian Mortgage News, Fixed rates, Interior home mortgage, Interior Mortgage Expert - Lisa Alentejano, Interior Mortgages, Kamloops home mortgages, kamloops mortgage, Kamloops Mortgage Broker, Kamloops Mortgage Broker - Lisa Alentejano, Kamloops mortgage consultant, kamloops mortgage financing, Kamloops Mortgages, Kelowna Mortgage Broker, Kelowna Mortgage Financing - Lisa Alentejano, Mortgage Broker Kamloops, Mortgage Consultant Kamloops, mortgage financing kamloops, Mortgage Playground - Lisa Alentejano, Mortgage Consultant, Mortgage Rates, Refinance Your Mortgage, Salmon Arm Mortgage Broker, Variable rates, Vernon Mortgage Broker

Breaking up with your mortgage

Variable rates are looking good

Its a dicey decision whether to break your mortgage or not. Most banks are not encouranging it but in some cases it makes sense.
Its a dicey decision whether to break your mortgage or not. Most banks are not encouraging it but in some cases it makes sense.

Anybody who bought their first house in the 1980s must marvel at mortgage rates today. Or perhaps fume.

Another rate cut this past week from the Bank of Canada led all of the major banks to lower their prime lending rate to a new low of 2.5%. (since this article prime is now 2.25%)

Consumers who locked into variable-rate mortgages tied to prime before credit markets tanked are getting as much as 90 basis points below prime and borrowing as low as 1.6%. It’s the deal of the century.

In October, the banks suddenly changed the rules on borrowing and demanded consumers pay a 100-basis premium over prime if they wanted to go variable. The banks have eased up since and the premium on a variable-rate product is 80 basis points above prime for a 3.3% rate.

It poses an obvious question for anyone who has locked into rates as high as 5.75% on a five-year fixed-rate mortgage: Should they break that mortgage?

“It probably does make sense to break it now,” says Vince Gaetano, vice-president of Monster Mortgage.

He gives the example of one client who came into his office this past week with a $205,000 mortgage and a 5.24% interest rate. The customer had 3½ years left on a five-year mortgage. The penalty to break his mortgage is the greater of three months interest or what is called the interest rate differential. The interest rate differential is the lost interest between your current rate and market rates.

In that client’s case, his interest rate penalty is calculated based on the current four-year rate at his bank, now 4.14% on a discounted basis. The lost interest to the bank is about $7,800, which is what the customer will have to pay.

It’s a big penalty but Mr. Gaetano argues that if that same customer breaks his mortgage and goes with the variable-rate mortgage at 3.3%, the savings would be in the $13,000 to $14,000 range over 3½ years — more than offsetting the penalty.

There is also a nifty little trick you can pull off if you have a prepayment option on your mortgage. Mr. Gaetano’s customer has a 25% prepayment privilege, so he can knock $57,000 off his mortgage and lower his penalty by about $2,800.

“You can access [that 25%] from an unsecured line of credit or some credit cards for a few days and reduce your penalty because the penalty is based on the balance outstanding,” says Mr. Gaetano.

While not encouraging people to break their mortgages, the banks are acknowledging that some consumers who locked into higher rates can save money if they refinance at the new lower rates.

“I think it does make sense as an option for some people trying to lower their rate,” says Joan Dal Bianco, vice-president of real estate-secured lending at TD Canada Trust.

She says if you are refinancing your mortgage, you can take the interest rate differential penalty and tack it on to your new mortgage. If you have credit card debt, you can add that on too, and the refinancing makes even more sense.

The office of consumer affairs for the federal government has a great site to help you make the decision: http://www.ic.gc.ca/eic/site/oca-bc.nsf/%20eng/ca01817.html. Moshe Milevsky, a professor at York University’s Schulich School of Business, who created the calculator used on the government site, says it ultimately comes down to how much money you will save on your mortgage if you break the contract.

“To me, it’s pure mathematics. There is nothing speculative or probabilistic about the decision to break a mortgage. It is the classic example of undergraduate finance time-value-of-money calculations. If the homeowner can refinance into a mortgage with an identical term that reduces monthly payments above and beyond any penalty costs, then go for it. Plain and simple,” says Mr. Milevsky.

Breaking your mortgage based on a decision to go into a variable-rate mortgage is an entirely different decision.

“This decision shouldn’t be confused or muddled with the classic long or short decision, or whether real estate prices or interest rates are headed up or down from here,” he says.

So, it comes down to two choices: The first is to break your locked-in mortgage and renew for another fixed term. If it saves you cash, that is a no-brainer.

The second choice is whether to switch products and go with a variable-rate mortgage. Historically, consumers have saved money 88% of the time going variable, according to Mr. Milevsky’s own studies.

I’m still in the camp that favours a variable rate.

Dusty Wallet This will not save you any money, but if you are strapped for cash because one of the breadwinners in your home has lost a job, the banks will let you lengthen your amortization period. If you have a 25-year amortization you can lengthen it to 35 years without any service charges — other than the huge jump in interest charges!

Gary Marr, Financial Post

Note:  Today’s variable rate mortgages with most lenders are being offered at prime (2.25%) plus .75% giving you a rate of 3.00%.

Author- Lisa Alentejano
Author- Lisa Alentejano
Advertisements

Author:

Finance/mortgage industry professional located in the Interior BC First Time Buyer Challenged Credit Second Mortgages Line of Credit Refinance Renewal Lets talk about your financing needs today! Great rates and Great Service!

5 thoughts on “Breaking up with your mortgage

  1. Lisa,

    There are some very good points in these scenarios!

    We’re seeing the same people who wanted the security of fixed mortgages a year or two ago now willing to pay huge upfront penalties to convert to a variable mortgage. Hopefully now they understand why variable mortgages have historically proved better off for home-owners in the long run!

    Emotional plays are not long-term thinking and I’m glad you wrote this. It always comes down to the numbers, not just the monthly payments either but the 5 to 25 year plan. It’s the client’s ability to pay down their mortgage as soon as possible and save thousands in interest over time that is important.

    It sounds like working with you gives your clients a plan, not just a mortgage. Well done!

    1. Hi thanks so much for taking the time to write your comments and let me know what you think. I really appreciate it.

      Have a fantastic day! 🙂

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s