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Mortgages: Some savings are penny-wise and pound-foolish


This well-known saying simply means that it is a waste of time to save your pennies while not paying attention to your dollars.

Unfortunately, it is a widespread consumer behaviour appreciated and even encouraged by big banks when you contact them for a mortgage loan.

Here’s how they do it. They offer you a low interest rate and a cash-back. At first glance, it seems quite interesting, doesn’t it? It would be hard for me to convince you that it’s better for your finances to pay more interest and refuse the cash-back cheques offered to you! Nevertheless, sometimes it’s better to say no … It all depends on your personal situation and how it evolves over time. The interest rate is only the most visible part of your mortgage contract. It’s the flashing neon sign that takes your attention away from the most important aspect of a mortgage contract: the product terms and conditions.

What are these? Here are the main ones:

– Penalty calculation

– Early mortgage repayment

– Subrogation

– Loan capital increase without new notarization

– Reduced interest rate used in the calculation of a blended rate instead of the current interest rate

– Portability

– Insurability

Each of these mortgage clauses can represent hundreds and, sometimes, thousands of dollars in savings or additional costs. Let’s take a look at the penalty calculations because this is the most costly.

Compare these two options:

A – ABC Bank offers a 5-year mortgage with 2,59% interest (rate offered) and a $1000 cash-back to cover evaluation and notary fees.

B – XYZ Bank offer a 5-year mortgage with 2,64% interest and a $500 cash-back paid by the mortgage broker.

The first observation is that the ABC cash-back really amounts to only $700. Why? The evaluation is usually payed by the bank when a mortgage broker submits a loan application. Since the evaluation usually costs $300, the real “gift” is only $700. And, it is a “gift” with strings because the $1000 is subject to a prorated repayment if the loan contract is ended before term!

Lets compare the difference between the two options on a 5-year $250,000 mortgage loan amortized over 25 years.

  ABC XYZ Difference
Rate 2,59% 2,64% 0,05%
Monthly payment $1,131.15 $1,137.42 $6.27
Residual mortgage after 5 years $211,976 $212,188 $212
Additional cost (60*$6.27+$212,188-$211,976) $588.20
Plus: cash-back difference: $700-$500 $200.00
Total ABC Advantage $788.20

This advantage is worthwhile only if the loan is carried to its 5-year term. Let’s see what happens in the current marketplace if you have to terminate your loan after 3 years and if the current rates prevail. You will have saved $6.27 a month for 36 months ($225.72), received a $200 cash-back. Your remaining loan will have decreased by $235 and ABC will have pocketed $660.72. But, you will have to pay a penalty either to ABC or XYZ, as calculated below:

  ABC XYZ Difference
3-month interest penalty $1,474.85 $1,504.21 $29.36
Penalty considering the different interest rates $7,288.82 $1,139.55 -$6,149.27
Penalty cost billed (maximum in each case) $7,288.82 $1 504.21 -$5,784.61
Repayment of the cash-back $400 $0 -$200.00
Total penalty $7,688.82 $1,504.21 -$6,184.61

The difference between the penalties is almost 10 times more than the savings up to that point! For sure, pennies may have been saved, but dollars now have to be paid. A lot of dollars!

Some may add, “But if I contract a new loan with ABC, I won’t have to pay the penalty!” It’s true you won’t have to pay up front. Instead, the penalty will be added partially or in totality to the blended rate that will be offered to you. This rate will be non-negotiable because you will have lost your main negotiating card – changing banks…

Moral of the story: All that glitters is not gold! Before choosing your mortgage loan, take time to analyze your situation with a broker who will explain all the terms and conditions important to you. Perhaps a 2-year term might be better, maybe a floating interest rate? The goal is to lower your interest and other costs for the complete term of your loan. This goal is not always reached with 5-year terms… The interest rate choice should be made only after you have chosen the term and the other loan conditions.

Here is the link that explains early mortgage repayment.

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March 24 2023

1 Year Fixed 6.94% 5.99%
2 Years Fixed 6.59% 5.74%
3 Years Fixed 6.99% 4.94%
4 Years Fixed 6.99% 4.69%
5 Years Fixed 6.99% 4.69%
5 years Variable 7.05% 5.80%
7 Years Fixed 7.00% 5.24%
10 Years Fixed 7.49% 5.89%
HELOC 7.70% 7.20%

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