Lenders have a book of tricks to keep you tied to them for as long as possible. One of their strategies is the "early mortgage renewal."
An early renewal offer can seem like a gift horse, and often it is. But it's a gift horse that you'll want to look squarely in the mouth. The reason: Early mortgage renewals are meant to keep you from comparison shopping.
If a lender can entice you before you talk to their competition, its chances of retaining you as a customer rise dramatically. That's why banks are increasingly asking people to renew more than 120 days before their maturity (renewal) date. This prevents people from securing long-term rate guarantees that are lower than the incumbent lender's renewal offer.
Every year, hundreds of thousands of homeowners renew early. This Globe and Mail story from Rob Carrick cites data that six in 10 borrowers renew before their maturity date.
When it comes time for your lender to come knocking with an early renewal offer, here's exactly what you should and should not do:
1. Do consider all switching costs and savings when calculating if an early renewal offer is worth it
· Potential legal, appraisal, discharge and title insurance fees: Most of the time, if you're merely switching lenders and not changing your mortgage terms, you don't have to pay legal and appraisal fees. But if you're refinancing at renewal (e.g., borrowing more money, adding a secured line of credit, changing the borrowers on title or increasing your amortization), appraisal fees often do apply. On top of that, your previous lender will ding you with discharge or assignment fees, which are over $250 to $300 in some provinces. Refinances also require title insurance of $150 to $250, and sometimes much more depending on the lender, mortgage size and type of mortgage transaction.
· Interest savings before maturity: For homeowners renewing a 5-year fixed mortgage today, their new rate could be up to 1.5 percentage points lower than when they got their mortgage the last time. If your lender offers to lower your existing rate months before your scheduled renewal date, that savings must be factored in.
2. Do consider the risk of rising rates
"In this market there's more upside rate risk than downside risk," says Scotiabank's managing director of real estate secured lending, David Stafford. And rates can change on a dime. In 2013, rates shot up almost three-quarters of a per cent in less than five months. "You would have really liked locking in that April, but not in October," Mr. Stafford adds.
So if you're granted a fantastic fixed rate six months before renewal, with no fees or switching hassle, that is compelling–especially for a risk-averse borrower. Remember, excellent rates in the open market rarely have rate guarantees (a.k.a., rate holds) longer than 120 days.
If you plan to go variable instead, rising rates are less of a concern. Variable rates are usually based on a discount to prime rate, and borrowers can't control the direction of prime rate. Moreover, variable-rate discounts from prime rate don't usually fluctuate as much as fixed rates, so there's less risk of waiting.
3. Don't overestimate the risk of rising rates
"No one knows where rates will be in four to six months," says Drew Donaldson, Executive Vice President at SafeBridge Financial Group. "Lenders can use that fear of the unknown to their advantage by offering higher than market rates on early renewals."
It's estimated that five-year fixed mortgage rates have risen materially (i.e., greater than two-tenths of a percentage point over a six-month span) only about 26 per cent of the time. That's based on data going back to 1991 when the Bank of Canada began inflation targeting, a watershed event that pushed down interest rates long term.
In the one in four times when rates have risen materially over six months, the average increase has been 0.66 percentage points. They've risen more than that only 8.5 per cent of the time.
Interest rates are primarily driven by inflation, and the odds of inflation causing extreme spikes in mortgage rates are arguably lower than they've ever been. For financially stable borrowers, overpaying for rate protection can be a costly decision.
4. Do factor in the hassle element. Switching lenders will take three or four hours of your life, require a full application, paperwork and employment/income verification, among other things.
5. Do shop around
"Consumers need to be careful to not sign the lender's initial offer, even if it reduces their current rate by a full percentage point," says SafeBridge Financial Group's Co-founder Elisseos Iriotakis. Contact another mortgage advisor to "gain a second opinion" and verify the math, he advises. They can:
· Calculate your potential savings of renewing early.
· Confirm if your personal circumstances dictate mitigating risk and locking in sooner.
· Confirm if you're better off refinancing to pay off higher-interest debt, pad your retirement portfolio, or invest in a business, income property, education, renovation or whatever your goals may be.
6. Don't succumb to a lender's pressure tactics
Their retention personnel are trained to convince you that their early renewal promotion is a "limited-time offer." In truth, lenders commonly honour early renewal rates after the supposed "expiry date," as long as rates in general have not increased. If a lender pressures you to answer, and you're not sure if its deal is sound, stall until you figure it out.
Early renewal offers are not created equal. Like so many other mortgage decisions, they're an exercise in probability, mathematics and foresight, so analyze this gift horse carefully before accepting it.