Can you even believe rates are this low?
If you are looking for a great Mortgage Advisor that will work with your best interest at heart. Give Lorrie a call.
Can you even believe rates are this low?
If you are looking for a great Mortgage Advisor that will work with your best interest at heart. Give Lorrie a call.
When you’re shopping for a mortgage, what’s the most important thing? Most Canadians will say getting the lowest mortgage rate. While getting a low mortgage rate certainly matters, it’s important to recognize that there are other things to consider as well.
There’s a difference between getting the lowest mortgage rate and the lowest cost of borrowing. Getting the lowest mortgage rate is just that, the mortgage with the lowest rate. Whereas, getting the lowest cost of borrowing factors in other things like prepayments and penalties. In this week’s article, we’re going to talk about the latter, penalties.
When you sign up for a mortgage, probably the last thing on your mind is breaking it. But sometimes life happens and you’re forced to break it sooner than anticipated. It could be for many reasons: relocating for a job promotion, job loss, divorce, and the list goes on. If you didn’t take the time to ask about mortgage penalties when you first signed up for your mortgage, you could find yourself blindsided by a big penalty.
In this article, we’ll look at how mortgage penalties are calculated for variable-rate and fixed-rate mortgages. After reading this article, you’ll have a much better understanding of how mortgage penalties work and what to look for.
“Roughly 2 out of 3 people break their mortgage early, at an average of 33 months”
Dustan Woodhouse President at Mortgage Architects
If you’re signed up for a variable (or adjustable) rate mortgage, the penalty is pretty simple. You’ll pay three months’ interest for breaking your mortgage early. This is the most favourable mortgage penalty calculation (besides paying no penalty at all of course). Whether you’re with one of the big banks or a monoline lender, your penalty will be three months’ interest.
For example, let’s say your mortgage rate is 2.49% percent and you have a $500,000 mortgage balance. In this case your mortgage penalty would be:
2.49% × $500,000 × (3 months/12 months) = $3,113
Pretty simply wouldn’t you say? Whether you break one month into your mortgage over four years, three months in, your mortgage penalty is the same.
If you sign for a fixed rate mortgage like most Canadians, the mortgage penalty calculation is a little more complicated. You’ll pay the greater of three months’ interest or something called the “Interest Rate Differential” or IRD for short. If you’ve read stories in the media about Canadians paying huge mortgage penalties, the IRD is most likely the reason why.
Using the same numbers as above, even though your mortgage rate is only 2.49%, if you’re with one of the big banks whose posted rate is let’s 4.79%, that’s when it can really inflate your penalty.
Let’s say you have three years left on your mortgage and your lender’s three-year fixed mortgage rate is 2.25%. If we use the IRD, your mortgage penalty would be:
$500,000 × 36 months × 2.54% (difference between 4.79% and 2.25%)/12 months = $38,100
Because the IRD penalty calculation is greater than the three months’ interest calculation, you’d have to pay a penalty of almost $40k to break your mortgage early. I don’t know about you, but that’s a lot of dough!
The example we showed here is using one version of IRD known as Standard IRD which is based on the current posted rate for a similar comparable term. There are many other versions of IRD and penalty calculations. Some Lenders calculate their penalties on the posted rate at the time you got your mortgage, some deduct the discount you originally received of the posted rate, some require you to pay back the cash-back you originally received, some calculate penalties entirely differently, like 12 months interest or 3% of balance. The only true way to find your exactly penalty is asking your lender.
It’s important to ask about mortgage penalties up front so you’re not forced to pay a penalty out of pocket like this later on.
If you want a fixed rate mortgage, but don’t want to get stuck paying a huge penalty out of pocket, you may consider taking out a fixed rate mortgage with a monoline lender instead of the big banks. Monoline lenders don’t have high posted rates like the big banks, so your mortgage penalty is likely to be a lot lower when breaking your mortgage with a monoline.
This handy quick reference tool provides helpful information to submit applications to CMHC for homeowner and small rental loans, for all CMHC programs: Purchase, Improvement, Newcomers, Self-Employed, Green Home, Portability, and Income Property.
Some of the benefits of CMHC mortgage loan insurance include:
For homeowner loans (owner-occupied properties), the Loan-to-Value ratio for 1–2 units is up to 95% LTV. For 3–4 units, the ratio is up to 90% LTV.
For small rental loans (non-owner occupied), the ratio is up to 80% LTV.
For homeowner loans, the minimum equity requirement for 1–2 units is 5% of the first $500,000 of lending value and 10% of the remainder of the lending value. For 3–4 units, the minimum equity requirement is 10%.
For small rental loans, the minimum equity requirement is 20%.
For both homeowner and small rental loans, the maximum purchase price / lending value or as-improved property value must be below $1,000,000.
The maximum amortization period is 25 years.
The property must be located in Canada and must be suitable and available for full-time, year-round occupancy. The property must also have year-round access including homes located on an island (via a vehicular bridge or ferry).
A traditional down payment comes from sources such as savings, the sale of a property, or a non-repayable financial gift from a relative.
A non-traditional down payment must be arm’s length and not tied to the purchase and sale of the property, either directly or indirectly such as unsecured personal loans or unsecured lines of credit. Non-traditional down payments are available for 1–2 units, with 90.01% to 95% LTV, with a recommended minimum credit score of 650.
At least one borrower (or guarantor) must have a minimum credit score of 600. In certain circumstances, a higher recommended minimum credit score may be required. CMHC may consider alternative methods of establishing creditworthiness for borrowers without a credit history.
The standard threshold is GDS 35% / TDS 42%. The maximum threshold is GDS 39% / TDS 44% (recommended minimum credit score of 680). CMHC considers the strength of the overall mortgage loan insurance application including the recommended minimum credit scores.
The GDS and TDS ratios must be calculated using an interest rate which is the greater of the contract interest rate or the Bank of Canada’s 5-year conventional mortgage interest rate.
Single advances include improvement costs less than or equal to 10% of the as-improved value.
Progress advances include new construction financing or improvement costs greater than 10% of the as-improved value. With Full Service, CMHC validates up to 4 consecutive advances at no cost. For Basic Service, the Lender validates advances without pre-approval from CMHC.
Non-permanent residents must be legally authorized to work in Canada (i.e. a work permit). Mortgage loan insurance is only available for non-permanent residents for homeowner loans for 1 unit, up to 90% LTV, with a down payment from traditional sources.
Samantha Brookes has been warning Canadians to take a close look at the clauses in their mortgage contracts for years, but her refrain has become a bit more prevalent in recent months.
Since the Office of the Superintendent of Financial Institutions’ mortgage stress test was implemented in January, the founder of the Mortgages of Canada brokerage has seen “a huge influx” of Canadians who fail to qualify for a bank mortgage turning to alternative lenders that range from risky loan sharks to larger, more conventional companies like Home Trust.
While alternative lenders can provide a lifeline for Canadians who have run out of other financing options, Brookes said they come with pitfalls for those who don’t bother looking at the fine print.
“You need to read those contracts,” she said. “(With an alternative lender), the interest rates are higher, the qualifying rate is higher than if you were going with a traditional bank and they are going to charge one per cent of the mortgage amount (as a lender’s fee) for closing, so that means your closing costs increase.”
Alternative lenders tend to offer less wiggle room on their terms, so Brookes said that means you should pay special attention to another dangerous term she’s seen slipped into mortgage contracts: the sale-only clause.
It’s less common, Brookes said, but if left in, it might mean the only way you can break your mortgage is by selling your home. She usually makes sure it’s nixed from her clients contracts immediately.
She also advises mortgage-seekers to research a potential lender’s reputation, which can easily be done online. Looking up some lenders will reveal their involvement in growing strings of court cases, she said.
“If they are constantly in court fighting with consumers for money, are you willing to put yourself at risk with that kind of person?” Brookes recommended asking yourself.
Still, she said alternative lenders “that don’t end up in court every two seconds” are out there and can offer a good mortgage, if you do your research.
Broker Ron Alphonso has seen what happens when you don’t look into your lender. He recently heard from a couple who borrowed $100,000 via a paralegal posing as a broker, who then convinced the couple to give the money back to him so he could invest it on their behalf. Instead of investing it, the paralegal disappeared to Sri Lanka with the funds, leaving the couple on the hook for the money and resulting in eviction from their home.
“They got very, very poor advice,” Alphonso said. “Apparently the person that arranged the mortgage was an agent and paralegal that has since been disbarred. If they had a lawyer working for them, at least the lawyer could have said (before they signed the mortgage) maybe this isn’t right.”
Alphonso recommends seeking advice from a broker, who he said should also be questioned about how tolerant a lender will be if you were to default on one of your payments.
Some lenders quickly force their clients into a power-of-sale or foreclosure, while others will find a way to work out an arrangement that will allow them to keep their home.
“If you are already in some kind of financial problem and you go to a lender that is not flexible, you make the situation worse,” Alphonso said. “If you miss one payment, (within) 15 days you can be in power-of-sale.”
When that happens, he often sees people refuse to leave their home and try to fight the power-of-sale or foreclosure. They take the matter to court and end up spending tens of thousands of dollars in legal fees that can eclipse any remaining equity they might have in their home.
If they lose their case, which Alphonso said happens often, they end up with a massive lawyer’s bill, no equity to cover it and no place to live.
That’s part of why he said those seeking financing should have an exit strategy to get out of any mortgages they sign with an alternative or private lender with a higher interest rate.
“Your goal should always be to get to a lower interest rate,” he said. “If they don’t go in with a true goal of how to get out of this private mortgage, there will be a problem down the road.”
Alphonso recommended looking for an open mortgage, where you can prepay any amount at any time without a compensation charge or a prepayment limit that you would often find in a closed mortgage.
Open mortgages come with higher interest rates, but give buyers the option to switch to a cheaper lender if something happens. However, switching does often come with penalties, he said.
Because some agents and brokers don’t give enough information or fully explain penalties and clauses, he said the best way to keep out of trouble when seeking a mortgage is to ask lots of questions and understand what you’re getting into before signing on the dotted line.
-TARA DESCHAMPS, Globe & Mail
The era of pleasant surprises for people renewing their mortgage is done.
Years of falling interest rates in the aftermath of the 2008-09 financial crisis taught a generation of home buyers that renewing a mortgage is a chance to reduce your payments. Now, we’re heading into the first wave of postcrisis renewals at higher mortgage rates.
If you bought your house five years ago and chose a mortgage with the ever-popular five-year term, rate hikes since last summer mean your payments are headed higher on renewal. Competitively discounted fixed five-year mortgage rates today run from 3.19 per cent to 3.59 per cent, depending on your particular home and mortgage details. Five years ago, a comparable rate was 2.74 per cent. The lowest five-year rate widely available in the past five years was 2.44 per cent in mid-2016, according to RateSpy.com.
David Larock of Integrated Mortgage Planners said he’s starting to hear from homeowners who are taking in this shift in rates. “I get e-mails from people once in a while to say, if you can get me my old rate of 2.49 per cent, I’d be happy to renew,” he said. “I have to break their hearts.”
Higher rates are just half the story. New mortgage-industry rules are complicating the process of taking your mortgage elsewhere if you don’t like the rate offered by your current lender. Vince Gaetano, a broker with MonsterMortgage.ca, said a lot of people seem to think the new rules applied only to first-time buyers. “Now, they’re coming up to their renewals and they’re saying, I had no idea this impacted me. I would have planned for this last year.”
The new rules require buyers with a down payment of 20 per cent or more to undergo a stress test that ensures they could afford their mortgage payments at the greater of the Bank of Canada’s five-year benchmark rate (now 5.14 per cent) or the actual rate being offered plus two percentage points. People with down payments below 20 per cent already faced a stress test, but it was set at the five-year Bank of Canada rate and thus slightly less stringent.
For existing homeowners, the stress tests are a non-factor as long as they’re renewing their mortgage with their current lender. If they want to move the mortgage to a different lender, a stress test must be applied. Unless you can pass the stress test, you’re likely stuck with your current lender. Mr. Gaetano expects lenders, notably the banks, to use the new rules as an opportunity to become less competitive in the renewal rates offered clients who appear to be less creditworthy. Better rates may be out there, but these clients won’t be able to get them.
A recent column looked at how people refinancing their mortgages to add other debts must also pass the stress test now. Refinancing is a popular tactic used by people who are getting overwhelmed by their debts. How popular? Mr. Gaetano said about 80 per cent of his clients who are up for their first mortgage renewal have in the past refinanced as opposed to simply renewing.
The biggest rate shocks will be felt by people who thought they were being prudent borrowers by putting down 20 per cent or more and thus avoiding the cost of mortgage-default insurance. This insurance makes a mortgage more attractive to lenders because the equity built up in the house means they won’t lose money if borrowers can’t repay what they owe.
That competitive 3.19-per-cent, five-year fixed rate mentioned earlier is for people who started with a so-called high-ratio mortgage, where the down payment is less than 20 per cent, and/or for those who have a mortgage that is less than 65 per cent of the current value of their home. Also, the purchase price had to be below $1-million. The best rate applies here because the mortgage is insured against default.
Expect rates in the area of 3.39 to 3.59 per cent if you’re renewing a mortgage of between 65 per cent and 80 per cent of the home’s current value (for example, a couple that put down 20 per cent at the time of purchase several years ago) and/or had an original purchase price of $1-million and higher. The same applies to people who are refinancing when they renew.
If years of declining rates have reduced the motivation for homeowners to shop around for a mortgage deal, Mr. Larock expects that to change this spring. “If their costs are going up, a lot of people are going to be more inclined to see what else is out there.”
-Rob Carrick, Globe & Mail