Penalty Landmines in the ‘rate-war’

Penalty Landmines in the ‘rate-war’

Spring has Sprung!

Short Version

  • There is no mortgage rate-war
  • Mortgage Rates are likely to remain flat or drop lower still.
  • What will drive rates up?   Good economic News.
  • Maintain focus on the Variable Rate Product.
  • 6 out of 10 CDN’s break their mortgages at an average of 38 months.  
  • Fixed rate clients, no matter the current rate, should budget for a penalty of ~4% of the mortgage balance
  • Variable Rate mortgage clients can expect a penalty of just ~0.7% of the balance.
  • Current clients 18 months into a 5yr fixed 2.99% – quoted a prepayment penalty by big bank of $16,481  increased to $19,712.00 by the time the completion date arrived) a 470K mortgage!
  •  Were this a variable rate product the penalty would have been ~$3,476.43 a rather significant savings.
  • Bottom line;  Have a serious conversation about the flexibility, merits, and safety of a variable rate mortgage with your Mortgage Broker.

Long Version

Along with a frenzy of activity in the Purchase and Sale market we also have a frenzy of activity around interest rates.

To be clear there is no mortgage rate-war as much as the media may wish to paint such a picture.  It is not as if the Banks have decided to write mortgages at a loss, or even at a ‘special’ deep discount this Spring.  Rather a shift in the economic fundamentals is leading to record low rates once again.  Signs of a struggling economy in which the Banks Profit margins remain strong at sub 3% interest rates.

To simplify it; Bad Economic News out of the USA and also Canada tends to precipitate lower interest rates.  Worried about a massive economic shock impacting rates?  As long as it is (more?) bad news then the result would likely be for rates to stay flat or drop lower still.

Rates Today

  • 1yr          2.89%
  • 2yr          2.49%
  • 3yr          2.49%
  • 4yr          2.79%
  • 5yr          2.89%
  •  Variable 2.45% – Prime (3.00%)  -.55

What will drive rates up?   Good economic News.  Aside from being in short supply this is rarely something that happens with short notice.  More likely economic good news will build slowly, and thus any eventual interest rate increases would also be somewhat gradual.   Along the lines of .50% or perhaps 1.00% over a 12 month period.  However all indications point towards a delayed start for such a 12 month period.  Likely late 2015 or even 2016.

Maintain focus on the Variable Rate Product;

Of note regarding variable rate mortgages is this recent story which indicates how stable Prime is.

Essentially todays variable rate mortgage is not very variable at all.  i.e. No change to Prime since Sept of 2010.

The larger issue as always remains prepayment penalties, even with a 2.99% rate.

Lurking like a landmine in this perceived ‘rate-war’ amidst an artificially manufactured sense of urgency to rush and ‘lock in’ there is, laying in wait, the ever present and often undisclosed Interest Rate Differential prepayment penalty.

Listed below is actual prepayment penalty data sent to clients Monday regarding their fixed rate 5yr 2.99% from Big Bank.  These clients are 18 months into a 5 yr term.  They fall into a group which now measures 6 out of 10.  6 out of 10 CDN’s break their mortgages at an average of 38 months.  

The prepayment penalty on fixed rate product is designed to eliminate the advantage of breaking the current agreement for a lower rate.  The penalty radically outweighs any benefit of a lower rate.

Much like each of the 6 out of 10 CDN’s breaking early, these clients never expected this would be the case for them.  100% of clients believe they will for the full 5yr (or longer) term.  Yet only 4 in 10 actually do.

This thing called ‘Life’, it happens!

It is worth noting that this mortgage in particular is not a ‘no frills’ product as is the current BMO offering – instead this is a fully featured mortgage.  Despite this;

 Balance $470,061

  • 5 yr term 2.99%
  • Matures 10/07/2017
  • Penalty $16,481

 Were this a variable rate product the penalty would have been ~$3,476.43 a savings of $13,004.57.

Bottom line;  Have a serious conversation about the flexibility, merits, and safety of a variable rate mortgage with your Mortgage Broker.  It is the product I continue to prefer.  As does the TD Economist with whom we were on a conference call with Monday.  When asked about ‘the next ten years’ his preference was also variable rate product.

For more around rates;

Have an excellent day!

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