Should you break your mortgage?

With dropping interest rates, there’s a lot of talk these days about whether to break your current mortgage and switch to a lower interest rate mortgage.  Here are the issues you need to consider:

1. The pre-payment penalty – You need to phone your lender to determine the penalty since the fine print in the mortgage documents will determine exactly what they will charge you to break your contract.  Lenders will charge you a penalty to break a closed fixed rate mortgage.  It is based on the interest rate differential (IRD) or three months interest (whichever is higher).  The reason for this is because the lender won’t be able to earn the same yield if you were to pay them back since rates have gone down.  By locking-in you get the peace of mind that you’re rates will not increase if rates go up.  By the same token, if rates come down, the lender (and its investors) expect that the yield will be the same so they recover this loss by charging you a penalty.  Each lender will have in its mortgage documentation the exact calculation for the penalty.  The penalty can vary among lenders so I suggest you phone your lender and ask the exact amount they will charge to break the mortgage.   Once you know how much it will cost to break your mortgage, I can calculate how much you would save by switching to a lower rate mortgage.
2. The type of mortgage you want to switch to – Your options are to switch to another fixed rate mortgage or move to a variable rate mortgage.  You’ll obtain the most benefit if you were to switch to a variable rate mortgage.   If you switch to another fixed rate mortgage, you will often find (with exceptions) that the penalty will negate most of the savings.
3. Whether you have the cash to pay the penalty – If you have the cash to pay the penalty, your mortgage can usually be “switched” to another lender without having to pay the legal and appraisal fees.  If you don’t have the cash, the penalties can be added on to the new mortgage but this will be treated as a “refinance” transaction whereas you will have to pay for the legal and appraisal fees.   Secondly, adding penalties to the new mortgage will require that there is enough equity in the property.

In most cases, the decision boils down to your answer to the following question:  Where do you think interest rates are heading? If you think interest rates are heading up, you should lock into another fixed rate mortgage and extend the term.  On the other hand, if you are of the opinion that interest rates will either stay the same or drop, you probably want a variable rate mortgage.   At our practice, we take the time to meet with with our clients personally to discuss in detail  interest rate trends and the pros and cons of each option since we consider this to be a very important and complex issue.

Be aware that there is a time element to making this decision.  Once you’ve made the decision to prepay, you should act fast since the prepayment penalty will increase when interest rates drop.  I’ve had clients who hemmed and hawed when the prime rate was in the low 5% range and now, they are kicking themselves for not acting sooner.

Secondly, calculating the savings can be complex.  It involves calculating the cashflows over the life of your remaining term and obtaining the present value.  Be sure you make sure that your mortgage broker understands the complexities of this transaction.

One final word: If you’ve locked-in to a high fixed rate mortgage, you should look into this option.  It could save you thousands of dollars in future interest.  Once the transaction is costed out, there is no downside.  They way I look at it, the prepayment penalty is money I will pay until the end of the mortgage term.  Either I pay it now or pay it later so it isn’t really an expense. Your major expense will be your time and effort in gathering up the paper work.

Understanding Your Home Purchase Closing Costs

Many homebuyers are startled to learn that after they arrange their mortgage they have to pay a range of additional fees to finalize the deal.  It pays to be informed, and we can advise you on these closing costs and on how you might be able to lower them.
What Are Your Closing Costs?
Your exact closing costs will depend on where you live, how much you are borrowing, how you finance your mortgage and your closing date.  Here are some of the most common costs:

1. Lawyer’s Fees – These vary across BC, and we can refer you to a lawyer who can assist you with your transaction
2. Mortgage Appraisal Fees – Lenders require an evaluation of the mortgage lending value of a property.
3. Land Survey – The legal written and/or mapped description of the location and dimensions of your land, obtained from an accredited land surveyor.
4. Title Insurance – May be purchased in lieu of a land survey in some cases.  Provides protection against several defects such as problems with the property that would have been revealed by an up-to-date land survey.
5. BC Land Transfer Tax – Buyers must pay this tax to the the provincial government when the property’s title passes from the seller.  The tax is equivalent to 1% of the first $200,000 and 2% of the amount above that.  First time home buyers can be exempt from this tax.
6. High Ratio Mortgage Insurance – Needed if you are buying a home for less than 20% down. This is a cost of obtaining a low downpayment mortgage and strictly a closing fee.  Most borrowers add this fee to the mortgage.
7. Home Inspection Fee – an objective visual examination of the physical structure and systems of a house, which most buyers opt for.

When you come in for a consultation, we will discuss what you need to prepare for in terms of closing costs so you are well prepared for the closing of your transaction.

Bank of Canada Cuts Key Rate by Half a Percentage Point

he Bank of Canada reduced its key interest rate by half a point today to its lowest level ever.  The Bank has cut this key rate by four percentage points since December 2007.  In its announcement the Bank stated that this rate is to remain at its current level or lower until there are “clear signs” that the economy is recovering.

The Bank also noted that “The effects of the recent aggressive monetary and fiscal policy actions in Canada and other major economies will begin to be felt in the second half of this year and will build through 2010.  Once the global financial system stabilizes and global growth recovers, the underlying strength of the Canadian economy and financial sector should ensure a more rapid recovery in Canada than in most other industrialized economies.”

Those with existing variable rate mortgages will benefit directly from this recent news – these mortgages are linked to the prime rate.  However, there can be some variation in when, or to what degree, lenders react to a Bank of Canada rate announcement.  There are lenders who change immediately after a Bank of Canada rate move, while some lenders re-set their prime rate on the first of the month following and some even do so quarterly.  In addition, after recent rate announcements by the Bank, some lenders matched the Bank’s drop only after a delay, and some did not match the full rate cut.

Currently, pricing for new variable-rate mortgages is typically above the prime rate.  Those looking for a new variable-rate mortgage may wish to get pre-approved, to protect themselves if variable-rate pricing in relation to prime continues increase in the next few months.

Pricing for fixed-rate mortgages is not directly affected by today’s announcement.  However, some fixed rates have been trending downward in recent week.