With the drop in mortgage rates some people are calling their banks to see what options they have to take advantage of the lower rates and save money on their existing mortgage. You will be offered the opportunity of blending your mortgage rate with no penalty. Or you can pay the penalty and do a new mortgage at the current rate. What seems like the best option may not be the case – always compare all your options before you sign.
Be careful when reviewing your options.
I do comparisons all the time for clients. Recently I was told by a major bank by blending your mortgage rate you could lower the current mortgage rate by .2% with no penalty. That didn’t make sense to me since the current rate at the time for a 5 year fixed term was 2.89% which should have meant the blend would be at least a 1/2 percent less. But the person on the phone was certain. I then pointed out the difference was the penalty rolled into the rate. The person on the phone agreed. The sales pitch is no penalty — but in fact there is always a penalty — it just comes in different forms. So be clear on the numbers you are quoted for penalty or blending your mortgage rate so you can do a fair comparison of your true costs and savings.
We compared the cost of paying the penalty and in some cases it doesn’t make sense to pay the penalty versus blending your mortgage rate. This is in part because the interest rate differential (IRD) penalty with the major banks is calculated in such a way the penalty is more than double the true IRD. For more details on calculating the IRD see my previous blog post.
However, in some cases the IRD can be recovered in less than 12 months and with a new mortgage at a lower rate the option of paying the penalty is better than blending your mortgage rate. For example, a recent client with a $275,000 mortgage balance and 18 months remaining on their mortgage at 3.79% was offered a new blended rate at 3.67% when the IRD penalty was $3500. That represented a $100 per month savings in payments. A new mortgage with a rate of 2.89% reduced their payments by $300 per month recovering their penalty cost within a year and continued savings for the new 5 year term ($10,000 in interest costs versus the blended rate option). In the end the client was better off to pay the penalty rather than blending the mortgage rate.
Watch my video conversation on early renewal of your mortgage along with Margaret Reynolds on the limitations of bank mortgage protection insurance. Or call me anytime with questions or comments.