Mortgage Penalties

One of the biggest questions people need to ask when getting a mortgage is what will be my penalty if I break the mortgage.

This is so huge, seriously even more important then the interest rate you receive.  Within reason.

The mortgage penalty you receive if you break your mortgage can be calculated in many different ways.  Unfortunately our Minister of Finance, Jim Flaherty is not looking at protecting consumers, just protecting the big 5 banks. 

Below is a basic explanation between IRD (interest rate differential) and a three month interest penalty.

Let's take a quick look at 3 most popular ways on how mortgage penalties are calculated, imagining you are 2 years into a 5 year term with a 3.29% rate with a balance of 300k on your mortgage.  The lenders best current rate is 3.49%, bond yields are at 1.49% and posted rate at 5.29%.

• Lender A:  Your current rate compared to the posted rate.  Posted rate at 5.29% - 3.29% = 2.00%, so basically your penalty will be 2% amortized over the remaining three years, or to put it in reality $17,102.37 IRD plus discharge and/or re-investment fees $300 to $1,000.  Ouch!
• Lender B:  Your current rate compared to bond rate.  Your rate 3.29% - 1.49% bond rate = 1.80%, so your penalty will be 1.8% amortized over the remaining period which will work out to $15,379.94 IRD plus discharge and/or reinvestment fee.  Shitty!
• Lender C:  Your current rate compared to the lenders best discounted rate.  Your rate being 3.29% and the banks discounted rate at 3.49%.  You can see that if you broke your mortgage the bank will actually be able to lend that money out at a higher rate so the penalty will simply be 3 months interest or $2,445.46 plus discharge and/or reinvestment fee.  Much better!

Now let's just say you can get a lower rate and a Lender C.  That's a good deal plus if rates do drop you have a lower rate that a IRD will calculated on.  If rates go up your penalty will simply be 3 months interest. 

Rate is important but if you look at Lender A, is having a good rate going to benefit you if you break your mortgage and rates go up?  NO!!  It will make matters worse as the gap between posted and your discounted rate is bigger.  It should be illegal.  The bank is double dipping by charging you a massive penalty then lending that money out at higher rate.

With lender B markets would have to increase significantly before the spread between your rate and the bonds will be eliminated.  In the world we have now I would not be expecting that to happen.

Let's look at one more thing.  Let's say your favourite bank offers you a rate that another lender can't match.  (FYI, I'll always beat it.)  There is a difference 0.10% which works out to $15.61 a month, over the two years you have had your mortgage that is a total of $374.64 you would have saved.  But you decided to go with Lender A for the cheaper rate but life threw a curve ball at you and you have to break your mortgage.   Sorry, you are screwed, literally.  Me personally I would look at the higher amount as an insurance premium protecting myself.

You never know what life will throw at you.  There are many reasons mortgages must be broken, unexpected job loss, unexpected child or expected, could be work relocation, money needed for medical, a bigger home needed.  Whatever.  Most people say they will not move or break their mortgage but 75% of 5 years terms are broken within the 1st three years.

The best scenario is the best rate and terms, that is why you call me.

PROTECT YOURSELF AND FAMILY, talk to someone who is truly looking out for your best interest and wants referrals from you and your family and is looking for clients for life.

Let me know if this was helpful, thanks.

Till next time, have a great day.

Ron Miller


905-667-0699
1-855-684-8326
ron.miller@butlermortgages.com
YouTube Hamilton Broker
@HamiltonBroker

Down Payment Requirement, Cash Back Mortgages

You can view all my videos on You Tube at HamiltonBroker.

This post is mainly aimed at explaining the cost associated with the size of the down payment you use to purchase a home. The ideal amount is 20% or more because then you can avoid default insurance premiums. You can buy a home with no money down, which is now referred to as a cash back mortgage, but it can be a risky way to get into home ownership, although it is sometimes the only choice. There is not longer 0% down payment in Canada, this was removed to help prevent a collapse in the Canadian mortgage market, such that happened in the States. You can still buy a home without a down payment it is just referred to as a cashback mortgage.

For the purpose of this post let's just look at a $200,000 purchase price for a owner occupied home, at 4% interest on a five year fixed with a 25 year amortization. If your down payment is 20% ($40,000) you will not have to pay any default insurance fees. There is a sliding scale for how much the default premium will be with less than 20% down. You can view this chart from CMHC "here". Not very many people have a 20% down payment when they are starting out so most do end up using mortgage default insurance.

Now for a 200k purchase with 5% ($10,000) down you are looking at an insurance premium of 2.75% or $5,225. This amount is added to your mortgage balance and works out to be $27.48 monthly integrated into your mortgage payment. You also have to pay $418 PST on this amount on closing as part of your closing costs. The total monthy mortgage payment would be $1,026.92.

Let's say you do opt for the 5% cash back. Your insurance premium will increase to 2.90% ($5,510) as well your interest rate will generally increase to the bank posted rate which is currently 5.69%. This higher interest rate is put into place so the bank can recoup the 5% cash back within 5 years. This increase in rate over 5 years works out to $188.17 monthly or $11290.20. Now remember you are paying back the bank your 5% ($10,000) down payment so it is actually costing you $1,290.20 ($21.50 monthly) to borrow the down payment. After 5 years you are free to switch lenders and return to normal interest rates.

One thing you want to keep in mind when considering this type of mortgage is your ability to break the mortgage. When you sign mortgage papers at a lawyers office you are entering into a contract. If you break this contract there is penalties either 3 months interest or interest rate diferential, whichever is greater. So lets say after two years you wish to sell the home and move to the islands. (P.S. I just added the link to be cute, they aren't paying me.)

Pretend current rates are around 4.5% you are still at 5.69%. The interest differential is basically the amount of money the bank is losing based on your interest rate compared to current interest rates. This is 1.19%, so the bank will calculate how much this is and charge you based on the remaining 3 years, basically about $6,700. Plus you will have to pay back the remainder of the down payment still outstanding, around $6,000, a total of $12,700. The average home increase in value about 4% a year which will give you an additional $16,320 of value but with a 5% Realtor fee and lawyer costs this adds up to aproximatley $25,700 to sell your home. This does not leave you with much left over.

Lets look at the numbers:

$200,000 Purchase
-10,000 Borrowed down payment
+ 5,510 Insurance premium
$195,510 Mortgage balance

Two years later you decide to sell your home is now worth approximately $216,320. From this amount you need to subtract all costs to see where you stand.

$188,000 Aprox. current balance
+12,000 Realty fees and taxes
+1,000 Lawyer costs
+6,700 Penalty
+6,000 Remainder of down payment
$213,700 To sell

You may if your lucky end up with $2,500 in your pocket and this is assuming the market does increase in value.

If you decide to sell and move up to a bigger home your bank may allow your to do so and give you a blended rate if you have enough equity in your home or additial funds for a large enough down payment.

Often people will recieve gifts from parents to use as the 5% down to avoid the extra costs. Not everyone has this option. There is 1-4% cash back options if you have some money.

I am a fan of the 5% cashback mortgage as long as people are aware what they are getting into and accept the reality and understand the big picture. It is a good way to get into home ownership especially if you are starting a family and do not have the time to save.

Feel free to reply or ask questions.

Thanks,

Ron Miller
Butler Mortgages
905-667-0699
ron.miller@butlermortgages.com

Mortgage Life Insurance vs. Term Life Insurance

The purpose of this post is simply to engage awareness regarding life insurance options. By no stretch of the imagination is this expert advice. I do not have a license in the insurance industry and I strongly recommend you speak to an experienced licensed professional.

When you are asked to sign mortgage papers, your mortgage broker or banker will ask you about mortgage life insurance. You then have to decide if you want it or not. The other option is life insurance, which is not connected to the home.

With mortgage life insurance you pay a monthly premium and if you perish the balance of your mortgage is paid off. With term life insurance you have a set policy amount and that does not change for the length of the term. If you have a $200,000 mortgage and you have mortgage life insurance in 10 years you may have a mortgage balance of $160,000, which will be the amount that is paid out. With term life insurance if you took out a $200,000 policy that will be the amount that is paid out. Usually the premium payments are about the same, you just need to decide what is the best value is for you.

One thing I want to make VERY clear. If you purchase mortgage life insurance with the lender that is holding your mortgage and you decide to switch lenders at your renewal for a better rate you will also have to re-apply for insurance as well. Now you are five years older, you may have had a minor or major health issue. Now what? How much will your new premium be? Maybe you can’t even get insurance. You are stuck with whatever rate your lender offers you because you can no longer get insurance. Most of the time if you bought your insurance from your mortgage broker it is transferable to a different lender. As well sometimes a bank will sell you transferable insurance, you just need to check your policy or have a qualified person check into it for you.

There are times when you may want the mortgage life insurance. You have not had the time to speak with an insurance specialist and are signing your mortgage papers. Once you sign that paper with your bank or mortgage broker and/or it is sent in for processing you are covered, even if your closing date is still three months away. After you have spoken with an insurance specialist you can then cancel the mortgage life insurance. You may also want to sign as extra coverage, sometimes there may be little perks with the mortgage life insurance that suit your needs.

There are other options as well; disability insurance and critical illness insurance. To make sure you are properly covered and have all your needs met; it may be a good idea to speak with an insurance specialist instead of buying your insurance from a mortgage broker or banker. We refer out clients to someone who can help them with planning their retirement, children’s education, their investments as well as insurance needs.

Please feel free to comment or email me with any questions or concerns.

Ron Miller
Butler Mortgages
905-667-0699
ron.miller@butlermortgages.com