Lenders / Pre-Payment / Purchase / Rates & Terms / Refinance

When the lowest rate is NOT the best idea

A low interest rate is appealing because it means a lower mortgage payment. However, before you sign on the dotted line, it’s important to read the fine print that comes with that low rate. Here are a few details to inquire about before you proceed as they could affect your options down the road and potentially cost you thousands.

Additional Payout Penalty

Some discounted interest rates come with an additional payout penalty. Most mortgages feature 2 potential payout penalty calculations, it’s the higher of;

OR

To break the term early with some of the discounted rate products, instead of paying the higher of the two above calculations, a penalty equal to 3% of the outstanding mortgage balance could be charged! That can work out to thousands in some cases.

A mortgage commitment should always clearly outline the payout penalty calculation options. While it’s difficult to predict exact future payout penalty amounts, you will have an idea of the calculations used to determine them.

If you’re worried about a payout penalty because you “may” break your mortgage early, consider taking an open or a shorter term.

Locked in unless selling

While not all discounted rates come with an additional penalty to break your term early, some DO NOT ALLOW you to break your term early UNLESS you sell the home. This can be very restrictive if you want to refinance your mortgage to access unused home equity or you want to move to a different mortgage lender for another reason.

This type of restriction should be outlined in your mortgage approval commitment under the section referencing payout penalties.

Limited Pre-Payment Privileges

Most mortgages have some sort of pre-payment allowance where you can pay down extra against your mortgage balance without paying a penalty. The most common ones are;

  • Lump sum equal to a maximum of 20% of the mortgage balance each year
  • Increase mortgage payment amount by 20% each year

Some discounted rate products come with little or no extra pre-payment privileges allowed without penalty.

Collateral Mortgage

All mortgages are technically a collateral mortgage as the property is used as collateral to secure the financing. Another definition for a collateral mortgage is where the mortgage lender will register 100% of the home’s value against the title of the property. Typically, the lender is only registering the mortgage amount on the title, which is less than the property value.

A collateral mortgage reduces your ability to borrow more home equity because there’s no more room left on the title for a 2nd mortgage or home equity line of credit to be registered. The 1st lender has ‘taken’ up all of the homes value with their 1st mortgage registration.

The information about how much is going to be registered against the land title may not be clearly outlined in your approval documents. If you are unable to determine it from your mortgage commitment, ask your Mortgage Broker to obtain that information directly from the mortgage lender. Do be aware there are other implications of having a collateral mortgage charge registered against your land title versus a standard mortgage charge.

Is the discount really worth it? 

While a lower rate is great at the beginning, it can end up costing more if you have to break your term early. Below is a quick comparison between the different interest rates so you can decide if taking the discounted rate now is worth potential additional costs in the future.

$100,000 mortgage amount – 25 year amortization – 5 year termmonthly payments

Interest Rate Monthly Payment Interest paid during term Principal paid during term Balance at end of term
2.05% $426 $9,410 $16,142 $83,858
2.10% $428 $9,644 $16,054 $83,946
2.44% $445 $11,234 $15,464 $84,536
2.49% $447 $11,469 $15,379 $84,621
3.00% $473 $13,869 $14,526 $85,474
3.25% $486 $15,051 $14,110 $85,881

 

While the interest rate is absolutely an important detail, it’s not the only one to pay attention to when applying for home financing. Work with an experienced Mortgage Broker who can give you unbiased information about your financing options and read the fine print of the mortgage approval commitment in order to make an educated decision. Don’t forget to ask all the questions you need answered in order to make a choice you’re comfortable with.

For all your mortgage needs, contact Jackie at 780-433.8412 or info@mortgagegirl.ca. Put 35 years of mortgage experience to work for you. Follow on Twitter @mortgagegirlca.

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2 thoughts on “When the lowest rate is NOT the best idea

  1. Pingback: When the lowest rate is NOT the best idea — – Credit Made Simple

  2. Pingback: 5 Do’s and Don’ts for Homebuyers |

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