27 Jun

# Calculating Mortgage Payout Penalties

Posted by: Dave Melnyk

It is very common for people to believe that the rate is the most important consideration when selecting a mortgage product. In many cases, this is a reasonable assumption, many times customer are deciding between mortgage products that are very similar in rate. In this case, as in most, understanding the terms of the mortgage are more important than the interest rate. It is unfortunate that too many Canadians find themselves learning about one of the most important terms, which have a very negative effect on their financial situation when it’s too late, Payout Penalties.

When calculating a mortgage payout penalty, banks and broker lenders use the greater of:

• A 3-month interest penalty or
• The interest rate differential (I.R.D)

This is where the similarities end. Banks calculate their I.R.D. based on the discount off the posted rate for the nearest term at the time of payout, while the broker lender uses a re-investment rate. The bank discount is the discount you received at the time of approval.
The example that I am using is a mortgage with a balance of \$400,000.00 at 2.79% with 26 months left on the original 5-year term. The 2.79% rate from your bank was a 2% discount off the original 5-year posted rate of 4.79%. The broker lender does not deal in posted rates as such.
Interestingly enough, the bank posted rate for the nearest term of 2 years was 3.24%, and the reinvestment rate for the broker lender was also 3.24%.
For the broker lender, the reinvestment rate was higher than the rate on the mortgage paid out, so the 3-month interest penalty is charged. The penalty worked out to \$2,790.00.
The bank penalty was calculated using the original 2% discount subtracted from the 3.24% posted rate for a 2-year term. This resulted in the penalty being charged as the difference of 2.79% minus the 1.24% or 1.55% differential for the remaining 26 months of the term. The result was a penalty in the amount of \$13,433.33 or a difference of \$10,643.33. The banks not only get to charge the higher penalty but also get to reinvest the money at the higher rate. Win, win for the banks but lose, lose for the borrowers.
In the past three years, many Albertans had to sell their homes due to unforeseen circumstances. Do you not think that the \$10,000.00 plus in penalty differences would have been better in the hands of these Albertans or your hands versus going to the Ivory Towers on Toronto’s Bay Street?

13 Apr

# Is a variable rate mortgage wise in today’s Economy?

Posted by: Dave Melnyk

Ever since the variable rate mortgage was introduced, the question became do I choose the fixed or variable rate mortgage.  With the recent rate increases borrowers will usually choose the security of a fixed rate mortgage.  This does, however come with a premium as variable rate mortgages are generally 0.75% less than their fixed counterpart. On a \$350,000.00 mortgage this translates to a payment difference of about \$135.00 per month. You as the borrower can take the lower payment and use it for purposes such as:

1. Debt reduction –  Paying down higher interest rate debt such as credit card, lines of credit or accelerating loan repayments on personal loans.
2. Savings-   Invest in RRSP’s or RESP’s for your children’s future education or just keep it in liquid savings for future use.

The preferred method of using the payment savings would be to increase the payment on the variable rate mortgage to that of the fixed rate mortgage. The increased payment portion will assist in faster reduction of the principal on your mortgage. This will help to reduce the impact of prime rate increases over the term of the mortgage.  If the prime rate does increase according to what the economists are predicting, we can anticipate increases in prime of approximately 0.25% six months for at least the next 18 months.  This would now bring the variable rate mortgage to the same rate as what your fixed rate mortgage would have been.  With having use the increased payment you would still be ahead as initially you had the rate savings plus the increased reduction in your principal.  If the prime continued to increase by the same 0.25% every six months, it would take over 3 years for the variable rate mortgage not to outperform the fixed rate mortgage.  If the prime rate increases don’t occur as predicted, then the pendulum swings greater in the favor of the variable rate mortgage. The variable rate mortgage also offers the same prepayment options as other mortgages plus you have the benefit of lower payout penalties should the need to sell arise.

The variable rate mortgage does have the inherent risk of the prime rate increases, so if you the borrower feel the need for security opt for the fixed rate mortgage. Jencor Mortgage Corporation will be able to assist in getting you the borrower, the best rate for your individual circumstance.