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By Sean Cooper
Special to the Financial Independence Hub
Shopping for a mortgage in the near future? The mortgage rate matters, but it shouldn’t be the only factor you consider. There are so many factors to consider, yet homeowners often get fixated on this one factor.
When you’re shopping for bread at the supermarket, you most likely don’t just shop for the bread at the lowest price. You consider other factors, such as calories, sugar and nutritional value. So why do so many people do the same thing with their mortgage?
Mortgage rates should be one in a long list of factors. Your likelihood of breaking your mortgage is a lot higher than you think. Even if you get the lowest mortgage rate, if it comes with a hefty mortgage penalty, it’s probably not worth it. Let’s look at four factors to consider besides just the rate.
1. ) Penalties
It’s not a coincidence that mortgage penalties are number one. Mortgage penalties are such an important factor (perhaps more important than your mortgage rate), yet they’re one of the most overlooked factors. Here’s a stat that may change your mind: 6 out of 10 Canadians with a fixed rate mortgage break their mortgage at an average of 38 months in. Why do they break it? For many reasons: job loss, illness, job relocation and divorce, to name a few.
If you have a variable rate mortgage, the penalties are pretty straightforward: 3 months of mortgage interest. However, if you have a fixed rate mortgage, that’s where things get a little more tricky; and costly. You’ll pay the greater of 3 months of interest or the interest rate differential (IRD). The IRD looks at the mortgage rate your lender is charging today on a similar term mortgage. If mortgage rates are a lot lower today, then that’s when you can be hit with a hefty IRD penalty by your lender.
To avoid a hefty IRD, ask your lender whether the IRD is being calculated using the posted or discounted rate. If it’s using the posted rate, be careful. If you break your mortgage and have a big balance owing, your mortgage penalty could amount to thousands or tens of thousands.
2.) Portability
To avoid a hefty mortgage, it helps if your mortgage is portable. When your mortgage is portable, you can take it with you. For example, let’s say you’re living in Ontario and you get a job offer in B.C. If you sell your home in Ontario and buy a home in B.C, you can “port” or take your mortgage with you and avoid the hefty mortgage penalty. If the property that you’re buying in B.C. is more expensive, lenders often let you “blend-and-extend” your mortgage, which means you take your current mortgage and blend it with a new mortgage for the additional amount of financing you need.
A word of caution: all portable mortgages aren’t created equal. There are specific conditions that must be met in order for a mortgage to be ported. Sometimes the time window is tight, so ask your mortgage broker for all the details. Likewise, if you think there’s a possibility that you could transfer outside your province, avoid portable mortgages with credit unions. Credit union mortgages can never be ported outside the province you took them out, leaving you stuck paying the hefty mortgage penalty.
3.) Prepayment Privileges
Is your goal to be mortgage-free? Then you’ll want a mortgage with generous prepayment privileges. Prepayments are payments you’re allowed to make above and beyond your regular mortgage payments without facing a hefty mortgage penalty. Common mortgage prepayments include increasing your regular mortgage payment, doubling it up and making lump sum payments. What makes prepayments so powerful is that 100 per cent of the extra money goes towards reducing your principal (unlike a regular mortgage payment, which is split between interest and principal). This effectively can reduce your mortgage amortization period (the length of time it takes to fully pay off your mortgage) by years and save you thousands or tens of thousands of dollars in interest.
Although a lot of lenders offer the same prepayment options on closed mortgages, not all prepayments are created equal. Some lenders let you make lump sum payments on any of your regular mortgage payment dates, while others only let you make them once a year on your mortgage anniversary date (if you miss this date, you can to wait a whole year to make a lump sum payment). This is where your mortgage broker is worth their weight in gold. They can help you choose the lender with the most flexible prepayments if that’s something that matters to you.
4.) Standard versus Collateral Charges
Shopping for a mortgage? Ask your lender if it comes with a standard or collateral charge. Often it’s buried in the fine print. Increasingly lenders are switching from standard to collateral charges. Collateral charges can be good if you plan to borrow money from the equity in your home to finance home renovations, however, they aren’t without their downsides. A mortgage with a collateral charge makes it more difficult to shop around when your mortgage comes up for renewal. You could face legal fees and penalties if you’d like to switch to a lender with a more attractive mortgage product upon renewal. Lenders know this, so they aren’t likely to offer you their best mortgage rate upon renewal (the mortgage rate you get as a new client is often lower than the one you get upon renewal). You may be surprised to learn that some of Canada’s biggest lenders, such as TD Bank and Tangerine, offer collateral mortgages. So at least go in with eyes wide open if you’re signing up for this type of mortgage.
Disclaimer: Contact a mortgage professional to see if the strategies mentioned apply to your specific situation.
Sean Cooper is the author of Burn Your Mortgage and managing editor of mortgagepal.ca
