Most of us are pretty good at determining the value in our everyday purchases. Some people would pay a lot more for a shirt from Holt Renfrew, than they would for a common household brand. Also, we would spend more on a specific car brand because of its known durability and reputation. When it comes to our investments we have the same type of reasoning.
With mortgages, statistics tell us that we are not that savvy and we are happy to treat them like commodities, like gas or coffee. Gas is a commodity, because we buy it by price only. We buy it from the vendor that sells it at the lowest price. The belief is that all gas at the same grade is the same, and thus only price matters. I wish that Canadian mortgages worked the same so that we could just buy them by the lowest mortgage rate. They are not since they come with varying terms and conditions that can cost the borrower dearly.
Why don’t banks boldly display their lowest rates on boards outside their premises?
Banks make profit through negotiation and the illusion that mortgages are a commodity.
I say it is an illusion because your mortgage can have debilitating terms and conditions in them. A liter of gas does not. One lender offering a 2.49% mortgage can be vastly different to a lender with the same rate but alternate terms.
This might sound obvious, but remember that your bank earns interest from the money they lend you. They will do whatever they need to, to force your loyalty for the term of your mortgage. They demand that loyalty through unfair terms hidden behind enticing interest rates. Some of the ominous terms are collateral mortgages and closed mortgages. Others have been determined by CBC Marketplace and class action Canadian law suits.
Make sure that you pay close attention to your mortgage terms and conditions.
The key to saving money in mortgages and having flexibility, is to have a healthy mortgage. A healthy mortgage should have a low interest rate with future cost saving options.
Have a look at this list of privileges and features of a good and healthy mortgage:
1. Principal Amount Pre-Payment Privileges:
The principal amount is the mortgage balance that you owe to the lender. You should be allowed to:
- Make lump sum payments equal to at least 15% of the original mortgage balance without penalty.
Good lenders allow you to make these at any regular payment date, not just once a year or three times a year etc.
2. Principal & Interest Payment Pre-Payment Privileges
The Principal & Interest Payment is your regular mortgage payment. You should be able to:
- Increase this payment by at least 15% annually
- Reduce it to the original payment amount without penalty
Your mortgage should be portable. This means you should be able to:
- Sell your home.
- Buy a different one.
- Take your existing mortgage to the new property without penalties from your lender.
Mortgage portability protects the borrower from penalties and maintains their current mortgage rate.
An assumable mortgage allows the buyer to qualify for the seller’s mortgage and assume (take over) it. This benefits both parties:
- The seller does not pay penalties.
- The buyer is able to take advantage of a lower than market interest rate or other conditions.
Various lenders apply this privileges in different ways. The benefits here are:
- If the borrower cannot make a payment they are able to skip that month’s payment.
- Avoid a missed payment on their record.
In all cases the borrower has to apply to the lender for the privilege. It is an expensive option since the full missed payment is added to the mortgage. However, the cost incurred is still better than a missed payment on your record.
6. Mortgage Penalties
Mortgage penalties are the most important of all privileges and can be the most costly part of the mortgage if not attended to. Penalties have exploded in the last 6 years with new inventive ways of being created.
Different types of fees and penalties that can be incurred when breaking or moving a mortgage:
- Interest Rate Differential (IRD) Penalty
- Months Interest
- 3% Interest Penalty (Or a percentage of the mortgage balance)
- Re-investment Fees
- Discharge Fees
Lenders claim to all use the same formula when calculating their penalties, but the interest rates that they use are very different. The Table below shows just how much lender penalties can vary from lender to lender for the same amount. The major banks typically have penalties similar to IRD-2; the highest in the industry.
Mortgage penalties are a major reason why some borrowers are stuck in their higher rate mortgages. The costs associated with breaking their current mortgage for a lower rate, far exceed the benefits of the new rate.
7. Mortgage Penalty Discounts
Mortgage penalties are charged by lenders for breaking the mortgage before the maturity date. The penalties are charged to either:
- Recover the profits that the investor lost or
- As a fee for the privilege of breaking the mortgage.
Most lenders do not rebate penalties if the borrower stays with their current lender. This is because the lender’s investors demand compensation. However, some lenders discount them if the borrower stays with their current lender as a matter of policy. Work with lenders that have that policy and don’t just do it on a discretionary basis.
8. Mortgage Type
There are three types of mortgages:
- Partially Open
- Fully Closed
- Fully Open
The best mortgage for normal circumstances is a Partially Open mortgage. Avoid the fully Closed mortgage as much as possible since you can only get out of this mortgage type if you sell your home or at the end of the mortgage term.
9. Written Mortgage Reduction Plans
An internet search for “how to become mortgage free faster”, yields more than 1.5M results. So, why is it, with this amount of resources, that only 1% of Canadians accelerate their mortgage free due date. Research tells us that this is because financial management has little to do with information and a lot more to do with our behavior and habits.
Work with a mortgage provider who will provide you with achievable, written mortgage reduction plans. A good mortgage broker will coach you to healthy financial habits so that you can achieve your mortgage free plans in a responsible way.
10. Service Continuity
Finances are personal. This means I want to work with someone that I trust, have a relationship with and who knows my circumstances. When I discuss my finances with them I want them to know my story. I don’t want to have to repeat myself every three years to a different person if my financial institution transferred them. I suggest working with a provider who works for you in the first place. Someone who can fight for you if you don’t get the service that you deserve. Your broker should be able to do exactly that.
The next time you get a mortgage don’t just sign the mortgage commitment, educate yourself and ask the questions we provided above. Here is a to an empowered and mortgage free future.