The events of the last week have presented a remarkable opportunity to get a better rate on your existing mortgage. Whether it’s renegotiating with your current lender or breaking your mortgage for a better rate, here are 6 things you should know before you do anything.
- Government of Canada Bond Yields are the lowest they have been since the record lows of 2016 when we slid below 0.60% on the 5 Year. The lower bond yields fall, the more we can infer that the market believes the most recent rate cut won’t be enough to keep the economy going in the face of the impact of COVID-19 and other factors.
- As bond yields drop, so do fixed-rate mortgages and GIC rates – but while bond yields react instantly, mortgage rates and GIC rates follow with some delay. Lower posted mortgage rates likely mean that prepayment penalties will increase.
- The Bank of Canada reduced the overnight lending rate to 1.25%. This represented a 0.5% rate drop. The entirety of the rate drop was accepted by our Canadian Banks and the Prime borrowing rate in Canada is now 3.45%. This is good news for those of you in variable-rate mortgages.
- It is easier than ever before to decide on a fixed or variable rate. If you think the markets are being a little too fearful of the permanent impact of COVID-19, then you want a fixed rate. If you think this is the start of a severe recession, you should take a variable rate. We have developed a strategy for optimizing your mortgage in this environment we can share with you.
- It is highly unlikely that there will be a better time to refinance your mortgage than right now. But if your mortgage is with a Canadian Bank you will probably need to act quickly. The way Banks calculate their penalties means your penalty will start to increase significantly in the coming days.
- The monetary stimulus we are seeing this week will cause real estate prices in Canada to rise.
Starting Point: Fixed vs Variable
If you are currently in a variable rate mortgage, you are in luck! You held tight to what has been the best product in the Canadian market.
Variable rate mortgages are perfect for breaking. They usually only cost 3 months’ interest to break. If you have a variable rate with a bank, do not lock in with your bank. That will only hurt you when, and if, you need to switch with their hefty penalties to break fixed rate mortgages.
If your starting point is a fixed rate, request a payout statement now! The sooner you do, the more likely you will be able to define the size of your penalty before they start increasing. Fixed rates are decreasing; As they drop, the penalties start to increase. Banks have tricky ways to keep you in mortgages that you don’t want to be in. If you are in a fixed-rate mortgage, you should call us to discuss penalty reduction strategies.
Mortgage Penalties Demystified
There are a couple of important terms to keep in mind as we discuss this opportunity. The rate of interest you pay on your mortgage is your contract rate. If you got your mortgage from a bank, they determine your contract rate by starting with their posted rate and applying a discount. Each borrower gets a different discount to the posted rate depending on their circumstances and market conditions when they borrow. To put it bluntly, your bank charges you as much interest as they think they can get away with. Keep in mind that this only applies if you have a bank mortgage, if you took a mortgage with a non-bank lender, there are fewer nasty surprises, and far more reasonable penalties.
Most mortgage loans contain a prepayment penalty clause. The prepayment penalty is charged by the bank because if you pay out early, the bank won’t receive some of the interest that you promised to pay. In most cases, the prepayment penalty is calculated based on the interest rate differential when you refinance. If you started with a five year closed mortgage and you have three years left in your contract, the interest rate differential is the difference between your contract rate and the posted rate for the maturity that most closely matches your remaining term. Any discount that you received when you got your mortgage is used to reduce the posted rate for the term most closely matching your time to maturity when calculating your prepayment penalty.
Suppose you borrowed $200,000 from your bank three years ago in a five-year, fixed-rate closed mortgage at 3%. The posted rate at the time was 5%, and you got a 2% discount off of the posted rate. Now, the posted 2 year rate is 3%, so the mortgage rate used to calculate your penalty is 1%. So you need to cover the interest that the Bank is losing for 2 years, and each year that interest represents 2% of $200,000 or $4,000. This makes your penalty $8,000.
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The Strategy
It is becoming clear that we are very close to the lowest range that fixed mortgage rates will get. In the coming weeks, we will see fixed rate mortgages test new lows. For those of you refinancing, consider taking a variable rate mortgage now and locking into the lowest possible fixed rate in the coming months. We have variable rates as low as Prime -1.2%, that’s 2.25% on a variable rate mortgage. A critical part of this plan is using a non-bank lender who will allow you to lock into the lowest market fixed rate in a timely manner when it comes time. How long you wait in a variable, or whether you jump straight into a fixed rate, is a decision we should make together based on your risk profile. Make no mistake, this is an excellent time to take advantage of rapidly dropping mortgage rates.
Give us a call so we can help you take advantage of this opportunity when refinancing
