Now that the Bank of Canada has slashed interest rates to their lowest levels in 40 years and chartered banks have followed suit, you may think it's an ideal time to renegotiate your mortgage.
"For some people, it's wonderful. For other people, it doesn't mean anything," said Alan Silverstein, a real estate lawyer and author of several books on house buying.
So far this year, the Bank of Canada has cut interest rates eight times by a total of three percentage points. Chartered banks matched the move, cutting their prime lending rates to 4.5 per cent, and trimming mortgage rates.
While many people are rushing to get a piece of the lower rates, mortgage experts warn that renegotiating may not be for everybody. Lenders charge a penalty - sometimes hefty - for breaking a contract prior to the maturity of the term.
The trick is to calculate whether your savings outweigh the penalty. For Todd and Susan Riley, it did. They now have $1,000 in hand.
This past week, after a lot of discussing and number-crunching, the Rileys renegotiated their mortgage. The couple, who live in the Etobicoke area of Toronto, were in their final year of a five-year-term mortgage carrying a rate of 6 per cent. "The biggest catalyst for me was when they dropped the rates by three-quarters of a percentage point," said Mr. Riley, a minister at a Baptist church.
They signed on for a one-year rate at 3.9 per cent. Although the Rileys had to pay a $600 penalty on the interest, they received $1,000, which will likely go toward paying the principal on their mortgage.
The toughest decision the couple faced was whether to lock in for another five years. Mr. Riley said they opted to do it one year at a time, since they believe interest rates will still be attractive down the road.
It's tough to speculate how long interest rates will stay at these levels, but Bob Ord, president of mortgage broker Mortgage Intelligence, believes over the near term they may fall some more.
With the prime rate dropping steadily, however, he advises people to opt for a variable rate mortgage with the option to lock in when rates start to head up again.
A variable rate mortgage is more for the risk taker because it is tied to the prime rate. If interest rates are dropping, less of each payment will go toward interest and more will go toward principal. If interest rates rise, more of your payment will be interest and less money will be reducing your principal.
Most people, however, want a sense of security and tend to lock in for three years or more when they get a mortgage rate they are fairly satisfied with.
Nevertheless, there are penalties involved in breaking a contract. Some mortgage experts advise people to stick with their mortgage if they have only two more years to run. When you're down to the last six months or so, then you should go in and negotiate with the bank, experts say.
"The banks didn't get to be rich by being stupid," Mr. Silverstein said. "They don't just give [money]away. They want to be compensated for their rate differential. And whether you blend it in or pay a lump sum penalty, it's all the same." The most common type of penalty is the greater of the three-month interest penalty or the interest rate differential. Simply put, the three-month penalty is your present mortgage balance multiplied by your current interest rate and multiplied by three.
The interest rate differential, on the other hand, is the difference between the interest rate on your mortgage contract compared with the rate at which the lending institution can relend the money.
For example, a couple has a first mortgage of $150,000 at a 7-per-cent monthly payment of $1,050, with two years left to go. They see a new rate at 6 per cent, which would be a monthly payment of $959.71. If the bank lets them break their contract, it would charge them either the three-month bonus of interest of $2,625.00 or the interest differential of 1 per cent or $1,500 a year.
The couple would lose out because the difference in payment works out to roughly $90 a month or $2,160 for the remaining two years. There would also be a discharge fee of about $200 to the existing lender and $70 registration of the discharge.
The pair could opt for a blended mortgage, where the bank agrees to blend the rates to 6.5 per cent. This would work out to $1,004.74 a month, which would be beneficial to the couple. But it is also based on the supposition that they want to extend their mortgage for another five years above the current term.
The lender could slap on a penalty, but Frances Blau of Abacus Mortgages Inc. said the amount depends on how good a negotiator you are. "The banks are very much into retention, and if they haven't had a problem with you, they don't want you to go somewhere else," Ms. Blau said.
At a time when rates are falling drastically, experts say it doesn't hurt to talk to your lender about what your new payments would work out to be. If you find the lower rates offer attractive savings, try shortening your amortization period by making the same monthly payment that you did before. This way, you can pay off your mortgage faster.
"Go in and check it out," said Paul Mims, vice-president of marketing and strategy for CIBC Mortgages Inc. "The worst is you find out you don't save money."
The banks' mortgage departments are extremely busy with rates falling.
Rick Lunny, senior vice-president of real estate secured lending at Toronto-Dominion Bank, said the bank is seeing an "unprecedented number of consumers" who are coming in to negotiate.
Scott Brown, vice-president of residential mortgages at Royal Bank of Canada said "we will not recommend it unless you get a benefit out of it." However, lenders stress that each borrower's case is different and there are no set guidelines on who will benefit.
Experts say that when you are looking to renegotiate your mortgage, you should:
- Know your current balance, interest rate and term.
- Ask what the process is going to cost you.
- Ask your lender how the penalty is calculated.
- Sell yourself by telling them you have been a good customer.
It helps to know what the competition is offering. You can check the Internet and newspapers to find the rates of other lenders. Then have your lender match or surpass that, especially since you've been a long-time customer.
"You have to crunch the numbers. There is no alternative," real estate lawyer Mr. Silverstein said. "I'm not saying people shouldn't do it. I'm saying people have to crunch the numbers very carefully."
With the penalties in place, some consumers will find they're in the hole, and it's probably better to stick with their previous payments.
"You just can't run in and do it," Mr. Silverstein said.