Top 3 Factors You Should Consider When Getting a Mortgage
Real estate financing, whether you are purchasing your first home, purchasing an investment property or refinancing your current property, is likely the largest type of loan that you will ever take out in your life.
This means that the effects of the terms of the loan are exaggerated exponentially compared to any other type of loan.
So, it is important to consider the terms very heavily before choosing where you will take your mortgage from.
What are the most important things that I should get educated on when making my decision? Mortgages are complex and there are MANY variables to consider when you decide. You should consult a mortgage professional with Blink who is standing by to answer your questions. But, for now, here are my top 3 things to consider when you are getting a mortgage, in order of their importance:
1) The Breakage Penalty
Any mortgage you apply for will have a ‘term length’. These vary between 6 months to 10 years in Canada. The term length is how long you are committed to your chosen lender to have the mortgage and make payments. After your term is up, you renew the mortgage. This can be done with the same lender, or, a new one.
What happens if you need to get rid of your mortgage before your term is up? The mortgage lender, to recuperate lost interest earnings, will penalize you.
When would I ever break my mortgage term? There are many cases in which you may need to break your mortgage term and face the breakage penalty. Here are a few examples:
- You sell your house (life changes all the time, you never know!)
- You would like to switch to a different lender for a better deal
- You would like to refinance your house to access the equity in it
- You would like to switch your mortgage to lock in a particular interest rate for a longer period of time
There are multiple methods that mortgage lenders will use to calculate your breakage penalty when you find yourself in any of the above scenarios. They are:
1) 3 Months Interest
This is a common type of penalty used. This is the only penalty that can be used if your mortgage is a variable or adjustable rate mortgage. The calculation is quite simple.
Your remaining mortgage balance is $300,000 and your interest rate is 3%. If you break your term, you will pay a penalty of $2,250 by the 3 month interest calculation.
$300,000 x 3% = $9,000 / year
$9,000 / 12 months = $750 / month
$750 x 3 months = $2,250
2) IRD (Interest Rate Differential)
This type of calculation is very complex. The result of the calculation depends heavily on market factors of which you or I have no control over. When it comes to outrageous and dangerous mortgage penalties, the IRD calculation is usually the culprit.
I will not give details on exactly how this is calculated – that will have to be saved for another blog post. But, for example, like in the above scenario if your mortgage balance was $300,000 and you had 2 years left in your term, the IRD calculation (depending on current market conditions) – could go as high as $12,000! Ouch!
Below, when we talk about ‘Flexibility’ – this will be a major factor.
3) Flat Fee
Some mortgage products simply state that your penalty will be a certain percentage of your remaining balance at the time that you break your mortgage. For example, 2.75%. So with a $300,000 remaining mortgage balance, your penalty would be $8,250. Yikes!
4) Open (No Penalty)
Some mortgage products are considered ‘open’. This means there is no breakage penalty at all. But, these products will come with higher costs upfront.
This item is very important to consider. It ties in with the Breakage Penalty as well. There are a number of things that could affect your mortgage ‘flexibility’. Here are a few big ones:
- Breakage Penalty
- Bonafide Sale Clause
- Collateral Charge
- Conversion Options
By flexibility, we mean having the ability to change your mortgage as the need arises. A surprise move, job change and moving interest rates are only a few examples of when you would need flexibility. Having a flexible product also will allow you to capitalize on market conditions that are completely out of yours and our control. If rates drop, you may want to take advantage of a lower interest rate. If they rise, you may want to lock in for longer.
For all of the potential reasons that you may need to change your mortgage in the future, the breakage penalty, the bonafide sale clause, a collateral charge and conversion options will impact your ability to do so.
1) If the breakage penalty is high, you may not be able to afford to change your mortgage. With some IRD calculations or Flat Fee penalties, you may find that you cannot even afford to sell your house at a critical time. This is the most dangerous thing that will inhibit your flexibility.
2) The bona fide sale clause is included in some low rate mortgage products, so beware. This clause states that you cannot ever change your mortgage during the term selected UNLESS you sell your house. So, if you wanted to renew early or refinance, you’re out of luck.
3) The collateral charge is registered on the title of your property. It is different than a standard mortgage charge. The collateral charge cannot switch between lenders. So, if you ever wanted to change lenders (even on your renewal date!) you would have to pay extra fees to have the new mortgage registered. The collateral charge is used by the big banks in most cases… beware of this fine print.
4) If you take a variable rate, the lender will likely give you options to convert into a fixed rate at any time during the term of your mortgage. This could be helpful if interest rates continue to rise. BUT, be careful, some lenders are not as generous as others. When you decide to lock into a fixed rate, if you do, the lender will decide what the interest rate will be! Make sure you speak with a mortgage professional at Blink to make sure you are choosing a fair and generous lender.
3) The Interest Rate
Last, the interest rate should be something you consider! The interest rate is what is used to calculate your payment amount. A higher interest rate, means a higher payment. It means that throughout the term of your mortgage, more of your payments will be used for interest, and less will be used to pay down your balance.
The small differences in interest rates have a very small effect. The breakage penalty and flexibility of your mortgage are much more important. BUT, with all else being equal, you should absolutely consider the interest rate!
Complicated? Questions? Don’t worry, I am here standing by today to speak to you, and answer your questions. Contact me. We are ready to prepare the perfect mortgage plan that fits your needs.