The art of mortgage renegotiation ROB CARRICK
February 12, 2009
Falling mortgage rates have revealed yet another way the banks are charging their clients more in these financially stressful times.
Rates on mortgages have fallen a lot in the past several months, prompting many people to ask about renegotiating in order to cut costs. "The bulk of my business today is people breaking their mortgages," said Jim Tourloukis, a mortgage broker with Advent Mortgage Services in Markham, Ont.
The problem in breaking a mortgage is the penalty that lenders charge. Banks typically have two ways to calculate the penalty and recently they've switched to the more expensive one.
A little context may help you gauge how annoyed you should be about this. With a recession and global financial crisis hurting their revenues, the banks have been pushing up interest rates on lines of credit, charging more in service fees and adjusting credit card rules to extract more money from clients. Mortgage penalties are somewhat different in that they're mainly influenced by what's happening with interest rates.
boilerplate in mortgage contracts for penalties associated with breaking a loan to be set at the greater of three months' interest or the difference between the interest the bank could make on your mortgage as originally arranged versus lending money out at current rates.
Mr. Tourloukis explained that three months' interest was the typical penalty until rates began to fall hard in the past couple of months. Now, the so-called interest rate differential, or IRD, is the larger penalty.
"The spread between the client's rate and what banks can lend money for now has grown dramatically," he said.
If you have any thoughts of breaking your mortgage, get on it today. If mortgage rates fall further, and they could ease a little bit more, then interest rate differentials will grow in size and cost you more.
Mortgage brokers say breaking your mortgage is worth some thought if your current rate is in the low 5-per-cent range or more. Mr. Tourloukis said he's been renegotiating five-year, fixed-rate mortgages at 3.99 per cent for clients who several months ago signed up for similar loans at 5.79 per cent. Other mortgage brokers are showing five-year rates in the low 4-per-cent range.
The first step in breaking a mortgage: Ask your lender what your penalty would be. There's no standardized calculation of penalties, so your number will depend on your lender's own policies and personal circumstances like the amount you've borrowed and the number of years left on your mortgage.
In some cases, breaking your mortgage just won't make sense because of the steep IRD amount. "If you have a lot of time left on your term, it could be deadly," said Vince Gaetano, vice-president at Monster Mortgage in Toronto.
Practices vary widely among banks, but one method for calculating the IRD is to compare a client's original rate against the posted rate for the term that corresponds with the remaining time left on the mortgage. Example: You're two years into a five-year mortgage, so your IRD would be calculated using the current posted three-year rate.
Once you know your penalty, ask your lender to show you how much interest you'd save by renegotiating with the best possible current rate. If the penalty overwhelms the potential savings, then you have a couple of options beyond giving up.
One is to try and negotiate the penalty lower, or have it eliminated altogether. Mr. Tourloukis said lenders have the discretion to help clients out this way.
Another is to chop the amount of money you owe on your mortgage, thereby reducing the penalty for breaking the loan. The way to do this is to take advantage of the prepayment privileges built into most mortgages.
For example, you might be allowed to prepay as much as 20 per cent of your outstanding balance in a year without incurring any charges. Make this lump-sum payment and then get a quote on the penalty to break your newly shrunken mortgage.
There are a couple of strategies to look at if you'd benefit from breaking your mortgage but can't afford the penalty charge.
One is to take the cost and add it to your mortgage balance. In some cases you'll still end up paying less interest than if you stayed with your current mortgage.
Another possibility is a blend and extend, where you jump into a new mortgage that blends your existing rate with the lower current rate and extends your term by a few years. There's no penalty charged in a blend and extend, but you won't save as much as you would if you paid the penalty and got the best possible current interest rate.
"If you want the better rate, you have to come up with the cash," Mr. Gaetano said.
Breaking a mortgage
Falling interest rates mean it's a good time to look at the possibility of breaking your mortgage to lower your borrowing costs. Here's an
example of how this might work supplied by mortgage broker Jim Tourloukis of Advent Mortgage Services. The assumption used here is that you took out a $200,000 five-year mortgage three months ago.
Your rate
5.79%
Best current five-year rate
3.99%
Potential rate savings
1.80%
Interest savings from lowering your rate
$19,000
Penalty for breaking your mortgage
$12,400
Net benefit from breaking your mortgage
$6,600
Don't have $12,400 to cover the penalty charge? Then try adding it to your mortgage balance
Mortgage balance at the end of five years if you do nothing
$189,633
Mortgage balance at the end of five years if you add your penalty to your mortgage balance
$185,725
Net benefit to breaking your mortgage
$3,908
THE GLOBE AND MAIL
