The 5-year term on our mortgage is up for renewal in this month.
We’ve gotten stuck at one bank – and we’ve been too lazy to search elsewhere, mostly for the sake of convenience.
It has been easier to have all our eggs in one basket:
Is it possible that my financial institution “banks” on how lazy I’ve been?
So this seems the perfect opportunity to re-organize my finances in a way that benefits me – instead of the banks.
Don’t be afraid to shop for money.
After speaking with a mortgage broker, it turns out that we have excellent credit scores, which gives us more power than we realized. The only reason they are not even higher is that we’ve carried The Colossus for so many years.
“There’s a lot of times I look at people’s profiles, I think, I’ll ask for the interest rate they’re paying on things, and I say, ‘why are you paying that interest rate?’” explains Kathy Nutter, who spent her career in personal banking, and is currently a Maritime mortgage broker with The Mortgage Centre.
“Because interest rates are determined by your credit score. The better the credit score, the lower the rate they pay. So, yeah, you should be shopping for a rate.”
Refinancing is now more expensive
The federal government disallowed “back-end insuring” in November 2016. This was the banking industry’s undisclosed practice of insuring all refinanced mortgages with CMHC or Genworth, without charging a premium to the client – protecting the bank in case of default.
“I get a mortgage, the bank back-end insures it, I default and walk away, the bank goes after the insurer and gets all their money back that they’ve lent to the client,” Kathy says.
“So the bank is out no money – it’s the insurer that’s out, cause the insurer now has to take over the property, sell it, pay realtor fees, have a house-sitter for it, look after maintaining it.”
But when the government decided the banks were no longer allowed to use taxpayer’s money to protect them (CMHC is government-owned), the risk reverted to the homeowner. It had the unfortunate side effect of removing smaller players from the pool of lenders, because they could no longer insure or afford to refinance their clients.
The other side effect is that refinancing is now more expensive than buying a home with 5% down…
“The banks came back and said, ‘okay, we are going to put the risk back on the client, so anybody putting 20% down or is refinancing their mortgage is going to pay a higher rate, because it’s not going to be insured anymore.’”
Perhaps this move made sense on behalf of cities where the government feared a housing bubble was about to burst (resulting in rampant defaults), but it means home ownership is more expensive everywhere else – especially in places like the Maritimes where prices rarely fluctuate.
Related: Burn Your Mortgage Book Review
Should we consider a variable term mortgage?
Kathy explained the difference between variable and term mortgages, a discussion no banker had ever previously raised with us. For those of you who don’t know, here’s the rundown.
You pick a term and a rate which never changes for that term. If you need to break the term, there is a penalty. Depending on when you break it, the price can be significant. Banks earn a great deal of money from penalties.
Kathy says the average duration of a mortgage term is 3.7 years, when you consider: job transfer, marital breakdown, job loss, renovations, or just selling to downsize.
“And what’s the first term that everybody promotes?” she adds. “Five years.”
“Do they do that on purpose?” I asked.
“I don’t know,” she replied. Her eyes twinkled under a raised eyebrow.
“But my first question to this client is, ‘how long do you plan on staying in this home?’ Realistically, is it a starter home? You don’t want to put them in a term that is going to incur them a penalty. And some banks charge higher penalties than others.”
The advantage of fixed rate is that you know what your payment is going to be – no matter what – for that term. There’s no guessing.
Bankers don’t promote them, she says, because people prefer what seems safer.
“Variable can fluctuate,” she concedes, “but if you look at the historic figures over the last 12 years there hasn’t been a lot of fluctuation. It usually changes in increments of .25.”
A variable rate is based on the Bank of Canada prime rate – the lending rate, which is 3.45% as of this writing. Prime rate is based on the Canadian economy, and is reassessed every quarter, at which time you will be notified by your lender of rate and payment change, if any.
“It went up twice this year , but last summer it went down twice. Prior to that, nothing happened for four-and-a-half years. And prior to that, nothing happened for – I think it was three years.”
I asked her what an upward fluctuation would mean, in dollars and cents. “On a $100,000 mortgage, that means $11 per month. It means you can’t go get a combo meal from McDonald’s once a month.”
Here on the east coast, where we enjoy lower average housing prices overall, this doesn’t sound like a frightening increase.
But the more expensive your home, the scarier it might be.
Four reasons to choose variable term
Here are four reasons why choose a variable term, according to Kathy:
1. You can lock it in at any time throughout the contract…
So long as you finish the balance of the contract in a fixed term.
“So if by year two, you say, ‘I can’t sleep at night,’ you have to take at least a three-year fixed or longer. Year three, two-year fixed or longer,” and so on.
2. Penalties are cheaper.
It’s always three months’ interest penalty.
“On a $100,000 mortgage – I’ll use the highest variable rate just to show you – $665. And as the balance of your mortgage decreases, that decreases as well.”
This is much different than a fixed, which uses the interest rate differential formula and is invariably higher. “You only get into the smaller penalty in your last – in your fourth year.”
3. You are likely to save more interest than on a fixed rate.
Even if the prime rate goes up once or twice in your five-year term, Kathy explains, you’re historically below the fixed rate that you would have had. So you have saved more interest over the term than the person who had the fixed rate, over the long haul.
And it is a mindset, she emphasizes.
“You know what, if you’re eleven dollars away from losing your home – you shouldn’t have a mortgage. Seriously. Because you would have been paying more if you’d had the fixed.”
Kathy always tests her clients to be sure they can handle a variable mortgage. “When we go to qualify them in the system, we don’t use the rate they’re getting. We use the posted rate, to make sure that they can handle any fluctuation. So when I approve someone for a variable rate mortgage, I don’t use a 2.4 or 2.35, I use 4%, or 4.99, to make sure that they can handle any increases.”
And since new stress-test regulations was instituted on January 1, 2018 – approving everyone on a higher rate will not be just a good idea, but a requirement.
4. You can squirrel away the interest saved for a rainy day.
Or, better yet, use it to pay down high-interest debt.
“A lot of people don’t have emergency savings. Or people are so targeted on paying down their mortgage, but yet they’ll have an 8% line of credit. Target on that.”
Related: 10 Ways to Save on Home Insurance
Who should not choose variable?
If you’re tight at the debt-ratio threshold, Kathy thinks you should avoid it.
“I’m not saying the rates are going to go crazy or anything, but I wouldn’t want someone tight, where they have a huge mortgage. I wouldn’t want them to be anxious at night.”
Still, she says it is a perceived threat.
“People listen to the news too much. I had a couple of calls this summer, and they were like, ‘Oh my gosh, it went up twice, should I lock it in?’ and I said, ‘you didn’t call me when it went down twice last summer—how come?’ [they said] ‘Oh, yeah.’ ‘So you’ve had the glory of saving interest. You still want to lock it in?’ ‘No.’”
One last piece of advice
At any financial institution, it matters who’s sitting across from you.
The loans officer you’re dealing with is an employee who answers to management. They may have limited education or experience, or have little discretion with regards to discounting rates.
“Are they going to fight for you?” Kathy says. “Because…I mean, some banks…they’re all revenue driven… [It’s all about] filling their pockets. So if they can get a little two percent extra off you, absolutely they’re going to get it. You’ve got to fight for it.”
If the branch you’re dealing with is more interested in revenue than in customer service, too much discretion on rates might hurt an employee’s performance review.
But, as a consumer, that’s not your problem, is it? You’re giving them your lucrative business. Make sure you’re comfortable with the deal.
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