The mortgage penalty box – the potential cost of lending and ‘blending’
Are low mortgage rates capturing your attention these days? If you already have a mortgage at a higher rate than those currently available, you may be considering refinancing to take advantage of a lower rate. But is that always a good idea? It’s almost guaranteed that you’ll run into penalties and pre-payment charges – they are nearly universal in the Canadian mortgage market – that could offset any gains you might expect.
Why do I have to pay a pre-payment or penalty charge for refinancing my mortgage? When your mortgage lender provided your fixed-rate loan to you, they matched your loan against a funding source that was available to them. The pre-payment charge, or penalty, is meant to compensate the lender for income they have lost and other costs associated with the early payout of your mortgage.
What kind of penalties can I expect to pay? All major banks and mortgage lenders typically levy pre-payment charges of either the greater of 90 days interest or the Interest Rate Differential (IRD). The IRD is based on the amount you pre-pay and an interest rate that equals the difference between your original mortgage interest rate and the interest rate your lender can charge today when re-lending the money.
When can it pay to refinance my mortgage? If you are within the first three years of a five-year term, the impact of ‘blending’ your existing mortgage interest rate into a new rate and extending the term portion of your new loan may prove to be a wash – no win, no loss.
However, it is possible to take advantage of a lower rate if you are planning to refinance and add significantly to your mortgage amount. In this situation, the new, lower rate would apply to all of the ‘new money’ portion and the extended term portion of your new loan. The effect is that your blended rate becomes significantly lower.
Refinancing your mortgage might be the right cost-saving move for you. But to be sure, talk to your professional advisor who may also be able to help you find a lending source that won’t put you in the mortgage penalty box.
Reviewed: January 21, 2015
Written and published by Investors Group as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an Investors Group Consultant.