Everyone wants to find the lowest mortgage rate. There is a level of personal satisfaction and gratification that comes with finding the best deal. You may even land such a great deal that you can’t help but brag to all of your friends, co-workers and family about it! In fact, I encourage you to do just that! After all, you’ve landed a rate that is lower than anything else you’ve found, and you couldn’t be happier, so why not spread the word?
While it’s great to score a super low mortgage rate, there is a lot more to a mortgage than just rate. All mortgages are NOT created equal. Choosing a mortgage based on rate alone can end up being a costly mistake.
Terms and Conditions
Rate is definitely a key factor in mortgage shopping, but the terms and conditions are often more important than rate. Locking yourself into a restrictive mortgage for the sake of saving a few dollars per month can be a costly choice.
Below is a list of common restrictions that also need to be considered as well, and in some cases, they can be more important than the rate itself:
- High penalties to break the mortgage early
- Bonafide sale Clause
- Limited prepayment privileges
- Collateral charge mortgages
- Higher than industry standard prime rate
- Variable rate compounding
- Additional or hidden fees
Let’s explore each one of these restrictions in detail, which will help you to make the right choice with your mortgage.
Variable rate penalty
For the most part, variable rate mortgages generally carry a penalty of three months interest. Be careful here, as some lenders will base the three months interest based on prime rate, rather than contract rate (the rate your payments are based on). This can result in a difference in penalty of up to 25%. A $5,000 penalty vs. a $4,000 penalty for example. Not a deal breaker if the rate is lower, but it definitely affects the overall cost of your mortgage.
There are some variable mortgage products that will carry a penalty of 3% of the outstanding amount. This could result in a penalty of $15,000 vs. $5,000 (based on a mortgage amount of $500,000 at 3%). 3% and 3 months interest can look similar when reading through it on paper, so ensure you pay close attention to your approval documents. Any credible mortgage professional will bring this to your attention at the time they quote the rate, however there are many who won’t unfortunately. Always make sure you ask, and then verify it by reading the terms of the mortgage commitment. Not everyone will have your best interests in mind unfortunately.
Fixed rate penalty
Fixed rate mortgage penalties are most often written as the higher of three months interest or the interest rate differential (IRD). Regardless of the lender, it’s always written the same way. You need to be very careful here. Just because it’s written the same, doesn’t mean that it’s the same. When speaking about fixed mortgages, three months interest is three months interest. It’s the IRD that you need to be concerned with, which can vary drastically from one lender to the next.
Interest Rate Differential
The IRD is the difference between your current mortgage rate and the new rate offered at the time you break your mortgage. The rate used would generally be the rate for a term closest to what is remaining on your current term. In other words, the rate that the lender would be re-lending the funds you are paying back to them. The simplest way to explain it is if the rate at the time you break is higher than what you are paying, then you would pay three months interest. If it’s lower, you would pay the IRD. The calculation is more complex, but this gives you a basic idea of the concept.
The IRD can be calculated in different ways. The major banks use posted rates, then they subtract the original ‘discount’ that was given to you. This is the harshest method of calculating your IRD penalty.
The other major method is using the contract rate (the rate your payments are based on). This is the method used by most of the monoline lenders (lenders that only deal in mortgages). This is the most lienent method for calculating the IRD. These can be referred to as ‘fair penalty lenders’.
The penalty to break a mortgage with a major bank and some credit unions can be as much as 500% higher than that of most monoline lenders. This could be the difference between having a penalty of $5,000 vs. a penalty of $25,000. The difference can be significant!
Penalty is one of the most important things to consider when shopping for a mortgage. Few people expect to break their mortgage early, yet so many people do. If I were to ask 10 of my clients if they thought they would break early, all 10 would say no. Yet six of them will end up being wrong, statistically speaking. Five years can be a long time. Circumstances change, and life sometimes throws you curveballs. Being trapped in a high penalty mortgage proves costly for many.
If you plan on buying another home, you can always port your mortgage over to the other property, which would result in no penalty at all, but porting is often not the best choice.
Bonafide Sale Clause
This is where you cannot break your mortgage before the end of your term unless you sell your house. This means you cannot refinance or switch to another lender during your term. If you win the lottery, you are not able to pay it out in full. That would be a pretty nice problem to have however! If you sell your home mid-term, then the restriction is meaningless. At the end of your term, the restriction is meaningless. Note that some lenders may still let you refinance, but you are limited to the same lender. Other lenders may not let you refinance at all.
For the most part, a bonafide sale clause will not be an issue for the vast majority of people. However, if rates were to drop substantially resulting in money saving opportunities, then you would be stuck where you are. Unless you sell of course. Bonafide sale clauses can be found on some products with BMO, MCAP and CMLS. As with any added mortgage restriction, your mortgage professional should take the time to point out and explain this restriction at the time they quote you the rate.
If you think there is a good chance that you may need to refinance before the end of the term, then you’re best choosing a mortgage without a bonafide sale clause. Usually I like to see a discount of at least 0.10% on the rate to justify the clause. Even then, you’re definitely entering into a more restrictive mortgage, so if this is something that is even slightly concerning to you, then I would opt for a mortgage without this clause.
Limited Prepayment Privileges
Prepayment privileges can vary from 5/5 to 20/20. 20/20 prepayment privileges, for example, would allow you to increase your payments by up to 20% and/or pay up to 20% of the original mortgage balance per year. Any additional payment (over your scheduled payments) will be applied 100% to principal, regardless of lender. Most lenders will have standard prepayment privileges of 15/15 or 20/20. Some may also allow you to double your payments. You can generally do any combination of increase to payment or lump sum payments providing that the total prepayments don’t exceed the allowable lump sum limit. (Some exceptions apply).
Most lenders do no limit the number of times you can make lump sum payments throughout the year, providing that they fall on a scheduled payment date. For example, if you are making monthly payments, then you can make up to 12 lump sum payments per year. If you are on biweekly, then up to 26. With 20/20 prepayment privileges, this would allow you to pay your mortgage off in a little under four years. That’s on paper. Few people will be in a position to fully utilize their prepayment privileges.
If you want to double up your payments, a lender won’t specifically write in their terms that you can do so, however this can easily accomplished when the lender does not limit the number of lump sum payments. In fact, you can more than quadruple your payment! For example, if you had a $500,000 mortgage at 2.79% amortized over 25 years, your payment would be $2,312.68. Doubling up would allow you to increase your payment to $4,625.36. If you were to max out your 20% lump sum privilege and break it up evenly over the 12 monthly payments, then you would be able to increase your payments to $10,646.01 per month! That’s more than four times your regular scheduled payment.
There are some lenders who will limit you to making lump sum payments just once per year. If you were to make one lump sum payment of say $5,000, then you would need to wait until the next year before you could make another lump sum payment, regardless of the annual limit. Some lenders base this on the calendar year, while others on the anniversary year, so make sure you ask if this is something that is important to you.
If your goal is to pay your mortgage off as quickly as possible, and if the lender only limits you to 10/10 prepayment privileges while also limiting you to single prepayment per year, then another lender might be better suited to you. Even if the rate is a bit higher, you’ll come out further by the end of your term if you are able to aggressively pay off your mortgage.
Collateral Charge Mortgages
There are two ways in which a mortgage can be registered. As a standard charge or as a collateral charge. The vast majority of mortgages are registered as a standard charge.
With a standard charge mortgage, you’re free to switch to another lender at the end of your term at no additional cost to you. The only fee you would pay would be the discharge fee from your current lender (approximately $300-$400 in Ontario, $75 in BC, or $0 in Alberta). With a collateral charge however, there are third party legal and appraisal costs, which can amount to an additional $1,100 approximately.
The benefit to a collateral mortgage is that you have the option to register your mortgage for a higher amount than you are borrowing, which can save you on legal and appraisal fees should you need to borrow additional money mid-term. That’s IF you need to borrower more money. Even if you do, it’s likely that you’ll still pay legal and appraisal fees to switch lenders at the end of the term, so you are paying the fees either way.
Some lenders will cover some, or even all of these fees for you, however this usually comes at a slightly higher rate. One way or another, you’re paying the fees.
If you get any other loans, credit cards, lines of credit, etc, with the same institution that holds your collateral charge mortgage, then they may tie these into the collateral charge as well. This means that if you were in default on your credit cards, then you could be considered in default on your mortgage as well, even though your mortgage payments are up to date.
TD, Tangerine, and National Bank will register ALL new mortgages as a collateral charge. The additional costs to switch at the end of your term should then be considered before choosing one of these options. Also, any mortgage that has a second component such as a HELOC attached to it will also be registered as a collateral charge, regardless of the lender.
Higher Than Industry Standard Prime Rate
This applies to variable rate mortgages only. The current prime rate is 3.95%, which is the same with pretty much all lenders, including TD. However, TD has a special ‘mortgage’ prime rate, which is 0.15% higher than virtually all other lenders. TD may quote you a variable rate at TD prime -1.10%, which can sound like you’re getting a much better deal then another lender who has prime -0.95%, however the interest rate would be exactly the same at 3.00% in either case.
Variable Rate Compounding
All fixed rate mortgages in Canada, regardless of the lender, are compounded semi-annually. Variable rate mortgages however can be compounded either monthly or semi-annually. If considering a variable rate mortgage, this is something that you will need to confirm before moving forward with the option presented to you. You might have two lender options to choose from, both with the same rate, but with different compounding. This means that the options appear the same, however the one with the monthly compounding will carry a higher payment.
For example, let’s say you have a $500,000 mortgage with a variable rate of 2.80%, amortized over 25 years. With semi-annual compounding, the monthly payment would be $2,315.22. With monthly compounding, the payment increases to $2,319.37. That’s an additional $4.15 per month that is going straight to interest, even though the rate is the same. Not only that, but your balance at the end of your 5 year term will also be $136.89 higher than it would be with the semi-annual option.
Monthly compounding is common with some of the major banks, as well as some monoline lenders. There are however many low rate options with semi-annual compounding available.
Additional or Hidden Fees
For the most part, lenders charging additional fees, or having hidden fees is a myth. But since I’ve had many clients tell me that their bank told them otherwise, it’s worth mentioning here. There are no additional or hidden fees when dealing with any CMHC approved mortgage lender. Some lenders may require an appraisal, which you may need to pay for up front. This is common with both big banks, as well as non-bank lenders however.
If your situation is particularly challenging, meaning you can’t walk into any bank and get approved for a mortgage, then you may need to qualify through an equity lender, in which case would charge a fee, which is usually around 1% of the mortgage amount. This does not apply to qualified borrowers however.
Who is Handling Your Mortgage For You?
One more thing to consider is the person you are hiring to handle your mortgage for you and who you are taking advice from. If you walk into a bank that is known for having a more restrictive mortgage product, it’s unlikely that they will bring this to your attention. Banks put a tremendous amount of pressure on their staff to sell, and to push products that make them the most money. Don’t get me wrong, as there are many brokers who will do this as well. Not everyone will have your best interests in mind.
This is why choosing the right person to handle your mortgage for you is one of the most important decisions you need to make.
Just as with any industry, there are good and bad mortgage professionals out there, and it’s unfortunate that the bad outweigh the good. Never assume that you’re getting the right advice simply because you’re dealing with someone that works for your bank… regardless of how long you may have known them for. Never assume that you’re getting the right advice simply because you’re dealing with a licensed broker.
A mortgage is one of the biggest financial decisions you will ever make, so always ensure you put thought into the individual working on your mortgage for you. You can have a great experience, or it can end up being a nightmare. Don’t let just anyone arrange your mortgage for you.
Impact Of Mortgage Rate Difference on Your Payment
As you can see, there is a lot more to a mortgage than just a rate, and having the lowest rate does not always mean you have the best mortgage for your needs. A 0.05% difference in rate is equivalent to only $2.50 per month in mortgage payment for every $100,000 you need to borrow.
So next time you’re faced with two different mortgage options, ask yourself if it’s really worth saving the additional $10 per month (for example) by having a slightly lower rate or if you want to maintain your flexibility. Is the additional $10 per month really going to affect your lifestyle in any way? The payment won’t, yet a restrictive mortgage may. It can be a small price to pay to allow you to keep your options open throughout your term.
“Paul Meredith is the author of the Amazon #1 best selling book, Beat the Bank
– How to Win The Mortgage Game in Canada, and has ranked as one of the top
75 mortgage brokers in Canada since 2016. He was a finalist for Mortgage
Broker of the Year in 2018, and can be seen as the exclusive mortgage broker on
season two of TV’s Top Million Dollar Agent.”