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On April 21, the Bank of Canada lowered the overnight lending rate once again and the Bank’s passed the reduction along to us. Uncharted territory. Historic Lows. Who would have thought that we would have had rates this low? Last November the rates were going up, and into December they had risen again.
Many of you are wondering if it is worth while trying to get out of the existing mortgage and converting into a lower interest rate…
There is no easy answer and we have to assess on a case by case situation. Many of you have called, some we have suggested yes, some we have said no - because there isn’t enough equity into the property due to the market conditions which doesn’t allow you to add the penalty into your mortgage. Also, in some cases it is not worth it. So it is truly based on a case by case basis.
Pre-payment penalties
Banks create pre-payment penalties to recoup the money they expect to lose by renegotiating your mortgage to a lower rate. When you signed your mortgage, you entered into a contract with the bank, saying for ex. 5 yrs @ 5.5% borrowing $100,000. The bank then sells that mortgage to an investor. If you want to renegotiate the rate, the bank determines the loss of interest or Interest Rate Differential (IRD) to calculate the $$ it stands to lose.
Penalties range greater of 3 months interest or a loss of interest in the remaining number of months left in the mortgage. In essence the bank simply calculates the differential between what you were going to pay if you continued with your current mortgage versus what the bank can resell that money for in the current market.
Again, this is done on a case-by case basis, and in some circumstances, where it is a large mortgage with a lot of time left, the IRD penalty can be significant.
Worth Paying the Penalty
It is often still worth paying the penalty because the lower rate creates significant savings, but again it’s case-by-case. If you purchased or have refinanced since 2006 and have had 5% equity in the property at the time, there could be an issue; because of an equity situation, again on an individual basis we look at each case separately.
If you have a variable rate you can lock into a fixed rate at anytime with no penalty. It is a perfect time to look at your payment and possibly adjust the payment higher if you can because prime is so low and you can really pay off on your mortgage principal.
If you are in a Prime minus mortgage, when that mortgage is at renewal you will lose that rate because the banks no longer offer that prime minus product you will be in a prime plus situation. So take advantage of it now while you can. Call us to arrange an appointment at 905-623-9738.
Fixed rate mortgage pricing is tied into the bond market, which isn’t directly tied to the Bank of Canada.
If you have a mortgage rate of over 5.75% with a few years remaining on the term, it may be worthwhile to pay the penalty and take either the security of a fixed rate mortgage or the variable rate knowing that you will be probably locking into a fixed rate in the next year… make your payment at the level that you are currently at your over 5.75%... watch your amortization decrease, watch you mortgage balance decrease.
Converting to a variable rate does not mean that there is no risk to rising rates. Variable rate mortgages can convert to a fixed rate mortgage at any point in your mortgage term with no penalty at whatever the fixed rates are at the time of conversion.
The bottom line is that with rates this low, it’s also worth analyzing your current mortgage to determine if you are in a position to consider changing. Call for an appointment to discuss your options and together we will make the decision that is best for you.
For example, the penalty on your existing mortgage is $14,000 and you do not have the cash to pay that up front. The rates are so low that even if you increased your mortgage by another $14000 (to cover the cost of the penalty); both your monthly payment and your balance at the end of the term would be lower. Keeping the payment at your current level is the way to go then you would have even better savings at the end. But again, you have to work the numbers; this doesn’t work in every case… Use caution with capitalizing the mortgage penalty. There will be legal fees associated with the transaction. |
