So you have finally made the decision to become a homeowner. The world is telling you now is the time to buy. Historically low rates and a lot of homes to choose from BUT do you know what the penalty will be if you break your mortgage early?
You probably have every intention to stay in your new home (at least for the 5 years that you signed up for anyway). Did you know the average homeowner will do something with their mortgage within 36 months? (refinance, move, selling etc). Things happen in life. You may get a better job and have to move, you may have a relationship breakdown, sickness, bigger family the reasons to change you current mortgage situation are endless. So while rate is important IT is not the most important reason to take the mortgage the lender is offering.
Let’s talk about penalties to pay off the mortgage early. We are going to use fixed term rates which basically means your penalty will be 3 months interest or Interest Rate Differential ie IRD (An interest rate that equals the difference between your original interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of the mortgage) which ever is the greatest.
We are going to compare the big 5 banks (Scotia, TD, RBC, CIBC, BMO) with some of the mono lenders that are in the market today. (First National, MCAP, Merix, Hometrust, Street, RMG)
We are going to use the same assumptions for all the lenders. Clients starting mortgage balance was $225 000 in February 2013. They received a 5 year fixed rate of 3.49% and their monthly payments are $1122.17 based on a 25 year amortization. At this particular time the posted 5 year rates where at 5.23% (client basically received a discount off the posted rate of 1.74% from the big 5 banks). We also note that we are using rates dated February 6, 2015 in the penalty calculations. You will see that the big 5 banks are at the low end $8300 to high end $11800 in penalties while the mono line lenders are $3800 to $5100. See the full comparison here:
You will see in the chart that we used the banks current websites to determine their penalty charges and we used a formula to calculate the mono lenders penalties. There is no discounted rate with the mono lenders and this is the biggest reason for the lower penalties.
Now lets go one step further. Say the mono line lender had a 3.59% interest rate and the bank had the lower rate of 3.49%. The payment at 3.49% is 1122.17 while the payment at 3.59% is 1134.07, which is a difference of $11.90/mth. Now lets go even higher to 3.89% that has a monthly payment of $1170.16 for a difference of $47.99/mth. Take the 47.99 over 24 months we get $1151.76. Now add this to $4478.78 we get $5630.54 which is still $2762.23 LESS than the lowest big banks penalties. That great rate/offer you received is not looking so great anymore.
Now we mentioned that the penalty is also based on 3 months interest OR IRD whichever is the greatest. So when would the 3 months interest come into play? Let’s take the above example yet again but this time we will use an assumption that the current 3 year rates are 3.49%. This means the mono lines will be using a 3 month interest penalty. So $213275 x 3.49% = $7443.29/12=$620.27×3 to get a penalty of $1860.82. The banks still use the discount off rate so they would still be using the IRD penalty. That’s a difference of $6400.00-$9900.00 (It would be extremely rare for the big 5 not to use IRD to calculate a penalty).
So what does this all mean? The answer is simple. You need to ensure you know what you are signing. A mortgage is not just how much your payment will be. You need to know what your costs in the future are going to be. Put your self in a position today to have options in the future. This is where a mortgage broker comes in. We offer bank products but we also offer mono line lender options. There is a time and place for a bank product but make sure it’s your time and place and not theirs. If your situation dictates a mono line product then you need to be in that product.
You will hear that you can blend and increase or port your mortgage. The majority of lenders (big bank and mono lenders) allow this so this is not a reason to go with any one lender/bank. The days of going to a bank your parents, friends go to are over. This is your money and you deserve to have the best product for your situation. Going to one lender is not going to get you this. Do you take the first car on the lot? No you do your research, you test drive it, you review the options and then you make a decision.
As a broker I give you the options so you can make an informed decision. I work for you and not the lender. If you go to the bank they will offer you their products only. If you do not like that product then you go to another bank. This makes no sense when you can go to one place and get various options and lenders vying for your business.
To discuss this and all other options just give me a shout for your free consultation.
As always comments appreciated and encouraged
Eric Gall is the owner of Avanti Mortgages (operating as a mortgage specialist for TMG – The Mortgage Group Atlantic). If you are purchasing, refinancing or renewing your mortgage contact Eric or check out his website and apply online.