Whether you’re a first-time homebuyer or you’re renewing your mortgage, it’s important to shop the market for the best mortgage rate. The days of most homeowners strolling down to their local bank branch to obtain a mortgage may be numbered.
The share of new mortgages obtained through banks is dwindling. 42 per cent of all new mortgages in 2013 were obtained from a bank, while 40 per cent were obtained through a mortgage broker, according to CAAMP’s Annual State of the Residential Mortgage Market in Canada. In fact, overall mortgage broker share has increased from 25 per cent to 28 per cent since last year.
While a lot of homeowners are wising up to the benefit of shopping the mortgage market for the lowest rate, over half of homeowners still obtain their mortgage with a bank. When you’re obtaining a mortgage with the big banks, it’s important to find out about mortgage penalties. The big banks have some of the most costly mortgage penalties out there – you can end up paying thousands just to escape your mortgage early.
The Difference between Variable and Fixed Rate Mortgages
Although you may have purchased your home with the intention of living there until retirement, financial circumstances can change. You may have to sell your home and break your mortgage for a number of reasons, including losing your job, divorce and the death of a spouse. If you have a closed mortgage like most Canadians, you’ll most likely have to pay a mortgage penalty. The mortgage penalty is supposed to compensate the mortgage lender for the lost interest from paying off your mortgage early.
According to CAAMP, a quarter of homeowners (26 per cent) have a variable rate mortgage. With a variable rate mortgage your mortgage penalty is pretty simple: three months’ interest. The penalty with variable rate mortgages is the same across the board whether your mortgage is with a big bank or credit union.
Two-thirds (66 per cent) of Canadian homeowners have fixed rate mortgages. The mortgage penalty with a fixed rate mortgage can be very costly. Most homeowners lock-in with a 5-year fixed rate mortgage, not realizing it can end up costing them later on. With fixed rate mortgages, your mortgage penalty is the greater of three months’ interest or the Interest Rate Differential (IRD). Here is a good summary of why a 5 year fixed may be a bad idea.
How the Posted Rate of the Big Banks Comes into Play
The posted rates can vary a lot between lenders. While you can obtain a fixed rate mortgage for as little as 2.89 per cent today, the big banks are still charging as high as 4.99 per cent – what gives? If you’re willing to do the legwork, you probably negotiate your way to a lower rate, but the inflated posted rates of the big banks can still come into play.
You may be curious why the big banks have such uncompetitive posted rates – the main reason is the IRD. When the IRD is calculated, it uses a comparison rate. While most secondary lenders like First National use the discount rate when calculating the IRD, the big banks use their inflated posted rates. This can result in mortgage penalties adding up to thousands of dollars, even if rates haven’t changed much since you obtained your mortgage. Scotiabank was recently in the news when it charged an injured soldier a mortgage penalty of $7K for escaping his mortgage early.
Before signing up for a mortgage with a big bank you should really think long and hard. Although the big banks may be willing to match a lower mortgage rate offered elsewhere, you could still end up paying a costly mortgage penalty in the thousands if you need to break your mortgage early. There are ways to avoid and minimize mortgage penalties (some mortgages allow you to “port” or “blend and extend” if you’re purchasing a new home), so speak with a mortgage broker if you’re considering breaking your mortgage.
Did you ask about mortgage penalties when you signed up for your mortgage? Have you ever broken your mortgage and paid a hefty mortgage penalty?
About the Author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University. You can read some of his other articles here.