People always tend to ask “What’s Your Best Interest rate?”
I hear this question all the time, it’s not that I don’t think it’s important, quite the opposite. I believe that a great rate combined with the absolute best terms and conditions for my clients are more important.
Many clients spend so much time shopping for the best rate, they can wear blinders when considering what can in the end cost them big dollars. I like to ask, “what does a lower rate really mean to your bottom line?”
The extra principal paid (over 5 years) on a $350,000, 5 year fixed year mortgage at 3.34% versus 3.39% is $279.00
While the interest you save is $830.00 over that same 5 year period, that is $166 per year
To be clear, that is your hard-earned money, I do believe that you should keep or make the best use of that money. The Banking Industry have done a great job of making a mortgage a commodity that’s easy to sell. The lowest common denominator always comes down to rate. Time and time again ‘Bank A’ offers 3.49%, ‘Bank B’ offers 3.45% and so on.
The problem with that approach is that we have been conditioned to care only about rate. Most people never ask the question what happens if I need to break my mortgage for any reason or maybe you do ask; Your banker gives you a short answer about 3 months interest or Interest Rate Differential. What does that really mean? Why should you care?
Here’s why you need to care…
Lenders use a variety of methods when calculating a penalty on a fixed rate mortgage, let’s use a 5 year mortgage at $250,000.00, 3.55% original rate, 20 months remaining for the following exercise, remember fixed rate penalties are the greater of 3 months interest or Interest Rate Differential (IRD). How IRD is calculated is the thing:
Step 1. How to calculate 3 months interest penalty
- $250,000.00 x 3.55% = $10,725
- ($10,725.00/12) x 3 months = $2,681.00
Step 2. Discounted rate to discounted rate Interest Differential is the best possible option for clients
- the lender will consider the closest discounted rate to your remaining term, in this case 2 years at 3.19%
- The calculation 3.55% – 3.19% = 0.36% differential
- $250,000.00 x 0.36% = $900.00
- ($900/12) x 20 months = $1,500 Penalty
- In this example 3 months interest is greater than the Interest rate differential, so, you would pay $2,681.00 penalty
Step 3. Posted Rate to Discounted Rate Interest Differential is typical of the big five banks (with slight variations with each of them), this is best for the bank.
- The lender will look at the original discount that you received off of the 5 year posted rate to arrive at your discounted rate (2.30% at the time)
- Then subtract the artificial discounted rate (2.30% from the 3.19% = 0.89%) from your existing rate to calculate the differential
- $250,000.00 x 2.66% = $6,650.00
- ($6,650/12) x 20 = $11,083.33 Penalty
- The method uses the large discounts banks provide on 5 year mortgage, which you would never receive on a new 2 year fixed mortgage
Wow!!! The numbers are real. Every bank has their penalty calculation on their websites, but, they are difficult to find, difficult to understand and generally not explained when you sign on the dotted line. Here are links to the major banks penalty calculators:
In the fight to give you the best rate, I bet this information was overlooked, if you knew the details of their penalties would you have considered other options? There are far better options available.
I want to clarify that I am not opposed to banks charging penalties, after all, a mortgage is a contract and you are breaking that contract, so, there is a cost to doing that. I really believe that clients need to understand what is involved in calculating the penalties of their mortgage.
The argument I hear is that I just took this mortgage I won’t be paying it out. The truth is you may not, but, Life is full of unknowns and uncertainty.
IF is the middle letters of LIFE, the thing about life is you don’t know if something will happen whether good or bad in 1 year, 2 year, 5 years
Contact a licensed Mortgage Broker for true choice when getting your mortgage.
Morgan Vaughan is a licensed mortgage broker with over 18 years in the mortgage industry. Providing excellent service, expert advice.
Contact Morgan or call at 416-436-0179 to discuss your situation or get a second opinion.