Is the Best Mortgage the One With the Lowest Rate?
Shopping for a mortgage is about a lot more than just finding the lowest rate mortgage. If you’re shopping for a new car, you wouldn’t shop based solely on the lowest sticker price, ignoring important factors like the make, model and fuel economy, so why do so many of us do the exact same thing with our mortgages?
There are so many other factor to consider, yet some homebuyers seem to get laser focused on this one factor, the rate, often ignoring other important factors.
The mortgage with the lowest rate may be the best mortgage, but that may not be the case. As I like to say, the mortgage with the lowest rate can help save you hundreds, but the wrong mortgage product can cost you thousands.
Is it really worth saving 0.1% off your mortgage if it means you’re put with a lender with a stiffer mortgage penalty if you break your mortgage early?
With some lenders, the only way you can break your mortgage is by selling your property. (If you were hoping to refinance to take advantage of lower interest rates or consolidate debt, sorry, you’re out of luck.)
By being up front and honest with your mortgage broker, it will help him hone in on the lender with the mortgage that’s best suited for you. In some cases you might be better off choosing a lender with slightly higher mortgage rates and lower mortgage penalties and better prepayments.
Now that you know why the mortgage with the lowest rate isn’t necessarily the best mortgage, here are four other important factors to consider when shopping for a mortgage.
1. Mortgage Penalties
It’s not by mistake that mortgage penalties are first on my list. Mortgage penalties are such a crucial factor (maybe more important than your mortgage rate), yet they remain overlooked by many homebuyers. Here’s a statistics that may surprise you – 6 out of 10 Canadians who have a fixed rate mortgage break it at around the 3 year market.
Why do these homeowners break their mortgages? There are many reasons, including unemployment, falling ill, job relocation and marital breakdown, to name a few.
For those with a variable rate mortgage, the penalties are pretty simple: you’ll pay 3 months of mortgage interest. But if your mortgage is fixed, that’s when it can get more complicated and costly. Your penalty is calculated as the greater of 3 months of interest or the interest rate differential (IRD).
The IRD is calculated based on the mortgage rate your lender is currently charging today on mortgages of similar terms. If today’s mortgage rates are significantly lower, then that’s when you can be faced with a high IRD penalty from your lender.
To avoid paying a high IRD, ask your mortgage broker if the IRD is based on the posted or discounted rate. If it’s calculated using the posted rate, remember that the penalty could add up to thousands if you do eventually need to break your mortgage, so maybe it’s worth going with a lender with a slightly higher rate and lower penalties.
2. Porting Your Mortgage
Another way to avoid costly penalties is by porting your mortgage. With a portable mortgage, essentially you can take your mortgage with you and avoid the breakage penalties.
Let’s say you’re living in Ontario and you decide to move to Alberta to take a job promotion. When you sell your property in Ontario and purchase another one in Alberta, you may be able to “port” your mortgage and avoid the costly penalties. If the property you’re buying in Alberta costs more, then many lenders let you “blend-and-extend” your mortgage. When you do that, you can take your current mortgage and blend or combine it with a new mortgage for the extra amount of funds you require.
A word of warning: portability isn’t the same between lenders. Lenders have conditions you must meet for you to be able to port your mortgage. The time period you may be able to port your mortgage can be tight, so ask your mortgage broker for all the specifics.
If there’s a chance you could have to move provinces during the term of your mortgage, it’s best to avoid mortgages with credit unions (even if they’re portable). Credit unions can’t be moved outside the province you take them out in, meaning you are still faced with a hefty mortgage penalty.
Do you want to burn your mortgage and enjoy financial freedom sooner? Then you’ll most likely want a mortgage with generous prepayments. As the name alludes to, prepayments are payments you can make above your regular mortgage payments without paying a breakage penalty.
The most common payments include upping your regular mortgage payment, doubling it up and lump sum payments. Prepayments are so handy because the full amount reduces your principal (unlike a regular mortgage payment which is split between interest and principal).
Prepayments can shorten your mortgage amortization period (the period of time until your mortgage is fully paid off) by months or years and save you thousands or tens of thousands in interest.
While many lenders offer similar prepayments on closed mortgages, not all prepayments are the same. Some lenders allow you to 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 forget to make it on that date, you’ll have to wait a whole year to make a lump sum payment).
This is where your mortgage broker comes in handy. He can help you choose a lender with more flexible prepayments if it really matters to you.
4. Standard vs. Collateral Charges
Here’s a question many homeowners overlook when shopping for a mortgage. Does the mortgage come with a standard or collateral charge? Sadly, it’s often hidden in the small print. A trend in the mortgage industry is to switch mortgages products from standard to collateral charges. Collateral charges come in handy if you may borrow money from your home for renovations, but there are downsides to be aware of.
When your mortgages comes up for renewal, it will be harder to shop around. You could face hundreds of dollars in legal fees and penalties if you switch to a lender with a more attractive mortgage product upon renewal. Lenders are well aware of this. Unfortunately, this means that they aren’t as motivated to offer you their best mortgage rate upon renewal (the mortgage rate you receive 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 best known and 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.