Far too often I see home owners inquiring about refinancing their mortgage in Barrie to consolidate debt, separation/divorce or a major home renovation only to find out that their pre-payment penalty is outrageous. In most cases it prevents themselves from progressing into a better financial situation. It is critical to read into the fine print before signing the mortgage.
One of the biggest problems is the home owner’s belief that their life won’t change much over the next 5 years. Mortgage statistics show that close to 50% of mortgages will be broken before maturity, meaning that penalties should be a major concern for any new mortgage.
Here are a few tips to avoid excessive pre-payment penalties:
Borrow from a mono-line lender
There is a little known fact that most chartered banks in Canada use their posted rates to calculate their prepayment penalties. For example, one of the big five banks is offering a 5 year fixed mortgage through the broker channel at 2.99% but their current posted rate is 4.79% for the same mortgage. If, by chance, you had signed a 5 year mortgage with this bank at 2.99% and 3 years later needed to break the mortgage (for whatever reason) you would face their new “posted” rate (creating a larger gap between the two rates for interest calculations). I recently ran a scenario like this for a client & found that the bank penalty would be approximately $7,000, while a mono-line lender (a lender that only deals in mortgages) would only charge $3,200. The difference is due to the fact that the mono-line lender uses their discounted rate (2.99%) vs whatever the future “discounted” rate is, greatly reducing the amount of Interest Rate Differential (IRD) penalty.
Consider a variable mortgage
A variable mortgage penalty, by default, will always be set at three months interest vs. the Interest Rate Differential penalty outlined above. This calculation is generally much lower allowing much more flexibility for the home owner. There are risks though, variable rates do fluctuate so you’ll need to take a closer look at your affordability (although you do have the opportunity to convert your mortgage to a fixed rate if interest rates start to climb dramatically). Qualifying rules also make it more difficult to obtain this type of mortgage.
Analyze the length of your term
If you know ahead of time that your situation might change over the next five years signing onto a shorter term (maybe a 2 or 3 year term), this could help you mitigate the risk of higher penalties. Although this strategy might not be that attractive because you’ll likely find 5 year rates more attractive. This length of term seems to be more competitive because of its popularity with home owners.
Avoid collateral charge mortgages
Be carefully not to get caught signing a collateral mortgage. This can add unnecessary cost when refinancing or even trying to transfer or switch your mortgage at maturity. You will need to pay a lawyer to discharge your mortgage at a cost of $1,200 – $1,500. The lender will know you face this extra cost & likely won’t offer you a competitive interest rate on renewal.
Know your options with your current lender
Sometimes refinancing with your current lender is the best option because they’ll waive some or all of your penalty (depending how far into your term you are) to re-sign with them. Even in that case though be sure to check the rate they are offering you with a broker, sometimes they’ll try & take advantage of the situation. Maybe you can save more money with another lender’s lower rate while still paying out the penalty with your current lender?