The general consumer will be hard pressed when left to their own devices to shop on their own for their next mortgage, especially if they visit with one of the BIG banks. Typically they will talk about their most popular and profitable product, the 5 year FIXED rate mortgage. If you don’t know to ask for anything different, that is what they will recommend for you.

Working with a professional mortgage broker, the insight and value we can provide will help you not just get a mortgage, but build a personal home loan strategy to help you get farther ahead down the road, to better reflect you future needs and goals.

So here are the TOP 4 reasons why you need to look at a variable rate type mortgage product.

1) It’s always a cheaper interest rate: The current GAP between the Best in Market (BiM) fixed rate and BiM variable rate mortgage is a difference of = 0.60%— for the Average Canadian Mortgage Balance ($310K), that’s a savings of $159.57 that you don’t have to pay to the BANK for interest each month. Over the full 5 year term, you have saved over $9.5K in interest  – should nothing change in the prime rate (breaks down to just $29.70/month for every $100K borrowed).

2) It’s always a better monthly P+I repayment distribution which helps YOU pay down your mortgage loan balance quicker, and in effect, again pay less interest to the banks.

So –  which product’s monthly payment do YOU want to pay for principal? 59.32% of the lower payment’s monthly amount to principal or 51.15% of the higher payment’s monthly amount to principal?

3) More flexible contract terms, and cheaper to get out of if you need to. To break this type of mortgage contract the penalty calculations are SIMPLE– just 3 months interest calculated on the balance remaining, for the term remaining.

The average Canadian will do something with their contracts after the 3 yr mark so if you owed $281K after 36months of this contract, then your penalty to break about $1,500.

Whereas the FIXED is a very complicated math equation, with fine print, and potential claw backs on the discounts given up from. In the opening contractual terms, you agreed to pay them the full interest of $38,612. After 36 months, you may have paid the majority of that to them, but they will want the rest to full term – it is this calculation that can be quite severe.

YOU can always do a SWITCH into the remaining term fixed as well, should you wish to take that route – with additional costs. Most VRMs are portable, meaning if you don’t need any new money for your next purchase. You can take that existing contract with you to your new property.

4) Banks are NOT going to increase your VRM payment severely…. MYTH— you will have a legal contract term outlining the math equations associated with the Bank of Canada overnight prime lending rate. Most banks have a similar prime. Right now, (as of the last announcement BoC announcement on September 19, 2015) prime is 2.50% and holding…. most internal bank prime rates are now 2.70%. The discount associated with their prime is what they are in control of for the mortgage variable rate offering… BUT once you sign your five year contract that math equation WILL NOT change in the term. The only thing that MAY change is the Federal Government’s Regulated BoC Prime lending rate, and that is capped to a max of a quarter of a point (0.25%) as to not trigger a negative effect in the larger economy. A 0.25% increase (or decrease as we have seen twice this year) for every $100K borrowed is just a change of $12.24/month, which is manageable. Most lenders take up to 90 days to do the administration to change your interest portion of your monthly payment, which gives you enough time to speak with your mortgage agent to help decide if you want to SWITCH to a fixed. (no costs to do that)

Since 2005, the Bank of Canada Rate hasn’t changed much. Back then, it was 2.50%, and lenders had same as their internal prime rate. The Federal Government promised to keep rates low, and from June 2007 to July 2009, they froze that rate to a ZERO increase. We have only seen two increases since then, bringing the prime up to 3.00%, and on December 2010, the Feds again froze the rate, which resulted in NO adjustments until January 2015, when they opted to DECREASE the rate by 0.25%, down to 2.75 and again a second decrease in July 2015 to where we are now. The September 19 announcement has said they will keep rates at a zero increase for some time to come.

Knowing it’s an election year, it’s not likely that the politicians are going to mess around with people’s money — they want their votes… and frankly after the election, whoever the new minister will be…. will take some time to get up to speed in their new duties of that portfolio… so don’t expect much change for the next year. This was reiterated by Dominion Lending Centres’ Chief Economist, Dr. Sherry Cooper, at our most recent conference.

Conclusion: Overall effect of using the variable rate contract is this:

More flexible product, with a lower monthly expected payment; better redistribution of that payment to principal, resulting in a lower end balance to renegotiate in five years time (should nothing happen to the Prime in that term) AND if you want to be conservative, and have a set payment for your household budget then… why not use the lower VRM product and make the FIXED payment.

EVERY additional dollar you put down per month – is now all principal – reducing our overall loan, and now reducing the overall interested they CAN charge you in term.

… or… better yet… why not set that monthly payment difference aside into a TSFA account, and once a year, make a decision to either invest it, or pay down your mortgage balance, or do both.

Working with Dominion Lending Centres is not just about shopping for the BEST rate… it’s understanding the variety of products that are offered, and how best they can assist you in your own goals.

Okay so you have a mortgage. Let’s face it, it’s a contract with terms, conditions, rights and obligations for both you and the lender. However, now for whatever reason you need or want to break the contract before the end of the term. Many mortgage lenders will allow this provided they are compensated. You have a rate of x.xx%, the best they can lend to someone else right now is 1% less so they want the difference, known as Interest Rate Differential or IRD. Seems fair right? Right. However, as is often the case, the devil is in the details. It is the method of calculating IRD that borrowers should be aware of as not all mortgages are created equal.

Let’s look at a couple of methods commonly used with what we Mortgage Brokers call “A” business. A or AAA business is where everything on the file makes sense, good credit, documented income and a normal residential type property. This is the vast majority of mortgage business on the books in Canada.

Method A – Posted Rate Method

This method uses lender posted rates to arrive at the formula to calculate the penalty. Posted rates are generally used by major Banks and some Credit Unions. These are the mortgage rates you will see on their websites and you will recognize them because the rates will not appear reasonable. They subtract a discount from these rates to arrive at the actual lending or contract rate. Nobody pays posted rates. Let’s say the posted rate for a 5 year term is 4.90% but you are savvy, able to negotiate a discount of 2% and come away with an actual mortgage rate of 2.90%.

Everything is rolling along great for 2 years when, for whatever reason, you need to exit the contract. What will my penalty be you ask, hopefully of the lender, while silently begging for mercy? The answer; the greater of 3 months interest or IRD. Okay 3 months interest sounds good but IRD sounds scary! It can be scary as it is subject to a formula over which you have no control and can be easily manipulated. You have 3 years left on your contract, the lender says their “Posted Rate” for 3 year terms is 3.40%. You think great! My rate is 2.90% your rate is higher at 3.40%, no difference just 3 months interest and I’m outta here! Wait a minute…remember that 2% discount you negotiated? That’s right, it gets subtracted from the posted rate to arrive at the rate that will be used to calculate your penalty. So 3.40% – 2% becomes 1.40%. Who lends at 1.40%? No one. However, your contract rate is 2.90% – 1.40% equals a IRD difference of 1.50%, times 3 years left on the contract equals a penalty of 4.50% of your mortgage balance. Gulp! On a mortgage of $300,000 that is a $13,500 penalty.

The main underlying problem with this method is the fact the posted rates and /or the discounts, can be easily manipulated depending on the interest rate curve, to favour the lender. What happens in today’s interest rate environment with a gently sloping curve is that posted rates decrease from long term to short term however, so do the discounts. For example, a 2% discount on a 5 year fixed term is close to actual nowadays however, you would never get a 2% discount from posted on a 3 year term. Less than 1% would be more realistic.

Let’s look at another common and more favourable method.

Method B – Published Rate Method

This method uses lender published rates which are close to actual lending rates but do not include unpublished rates, which may only be available to Mortgage Brokers or Quick Close specials, among others. Generally these rates are used by Wholesale lenders, many of whom acquire all or most of their business from Mortgage Brokers. You will see these rates on the lender websites and will recognize them because the rates will appear reasonable. Let’s look at an example using the info above but let’s assume at outset you chose a Method B lender as opposed to a Method A lender and compare. Let’s assume your rate is 2.90%, which was the published rate at the time or a special your Mortgage Broker obtained for you. You want to exit the mortgage at the same 2 year point in time. What will my penalty be you ask, hopefully of the lender, while silently begging for mercy? The answer; the greater of 3 months interest or IRD. You have 3 years left on your contract, the lender says their “Published Rate” for 3 year terms is 2.60%. You think great! My rate is 2.90% your rate is 2.60%, not much difference…and you would be right! No discounts involved, just a straight up comparison. Your contract rate is 2.90% – 2.60% equals a difference of 0.30% times 3 years left on the contract equals a penalty of 0.90% of your mortgage balance. On a mortgage of $300,000 that is a $2,700 penalty. Much easier to swallow than $13,500!

Think these numbers sound too far apart to be real? Not at all. In the above examples I have used rates fairly close to actual. This means that in the time frame covered, above rates are and have been essentially flat or slightly declining. So even though rates are/have been roughly the same for the lenders at the time origination vs time of exit, which means there cannot be much harm accrued to the lender, one method produces a very punitive penalty. Doesn’t seem fair does it? The Government recently stipulated that lenders must better disclose their methods, be more transparent and use plain language. However, the Government did not mandate which methods are to be used. So it is buyer beware! As always, get independent professional advice. We here at Dominion Lending Centres can guide you through the maze.

Now the caveat: having said all that, we do in fact support the major banks and credit unions and send billions of dollars of mortgages their way each year. Why? Well, they have by far the widest product selection available in the marketplace. Mortgage products and structures that you simply cannot get anywhere else. This is important because the first question I am asked by a borrower is “can I get approved?” All else is secondary. When it comes to penalties, forewarned is forearmed! Best to know going in. A Mortgage Broker can advise what best options exist and will know which lenders use which methods or variations of them.

Moral of the Story: As always, get independent professional advice on which lender and options are right for you. Your local independent DLC Mortgage Broker can help.

Good to know tidbits:

A closed mortgage also works in your favour, after all, as long as you are not in default, the lender can’t call you up and say, listen we found someone else who is willing to pay a higher rate than you have and we want out, we would like you to repay us ASAP. Gasp!

Variable rate mortgages generally charge a penalty of 3 months interest, no IRD. However, this is not true of all. Again, get independent professional advice.

By law, if you have a mortgage term longer than 5 years and you exit after 5 years have elapsed, the maximum penalty is 3 months interest.