Penalty Calculations

"When a Certified Financial Planner (CFP) can’t figure out how to calculate his mortgage penalty, it’s got to be really tough for Joe Borrower.

Globe & Mail columnist Ted Rechtshaffen, a CFP, recently wrote about this very topic. He says: “My mortgage breakage cost truly is a mystery…I have read my mortgage contract…It can’t be found in the fine print.”

Like many banks, his (TD Bank) explains how to calculate its penalty, but people have to deduce the numbers to plug into the formula themselves.

Those numbers include:

1. The contracted interest rate (easy enough)
2. The posted rate at origination (not as easy)
3. The months left on the term (easy)
4. The relevant comparison rate (not as easy)
5. The current mortgage balance

To confirm these numbers, the borrower generally has to call his or her lender.

Wouldn’t it be nice, however, if you could log into your lender’s website and get this information with one click? It would, but lenders would much rather you call them for it. That way they can try to sell you a new mortgage.

A key point Rechtshaffen makes is that some lenders go out of their way to muddy the waters with respect to mortgage penalty calculations. They do that by:

• Not including certain inputs for calculating your penalty in their mortgage contracts (like the posted rate); and/or,
• Not telling you where to get the inputs on your own; and/or,
• Not clearly explaining (with examples) which term to use when determining yourcomparison rate; and/or,
• Writing penalty explanations in language that almost requires a law degree.

Penalty calculation shouldn’t be this cryptic. CAAMP says that 47% of people who refinance before maturity have to pay penalties. (It’s actually more than that if you include refis with blended rates [which have penalties built in].) So it’s not like this is some infrequent obscure need that borrowers have.

Lenders who believe they have their customers’ best interest at heart should provide a web page that clients can log into. It should provide an instant penalty quote, with a comprehensible explanation of how that penalty was calculated, showing the math.

RBC has a semi-workable solution with its penalty calculator. Unfortunately, you have to fill in the blanks yourself and few people will know what to enter for things like the “Discount off posted rate.”

In any event, one of the nice benefits of not getting a big bank mortgage is that your penalty is often based on discounted rates instead of posted rates. That often saves people hundreds or thousands of dollars. It’s even more meaningful given that most people break their five-year fixedterms in 3.5 to four years on average."

Rob McLister, CMT

CAAMP Consumer Survey Highlights

CAAMP just released its Fall Consumer Survey. Here are a few highlights from that report. To get your copy of the report visit CAAMP's website at www.caamp.org * The total value of owner-occupied housing in Canada is estimated at $3.017 trillion. Mortgages and lines of credit on these homes total $982 billion, leaving $2.035 trillion in home owners' equity. The equity is equal to 68% of the total value of the housing. * Among those who renewed or refinanced an existing mortgage during the past 12 months, 21% changed lenders and 79% remained with the same lender. The rate of switching has edged upwards - two years ago it was 12%. * Fixed rate mortgages remain most popular (60%). * Among borrowers who renewed, a large majority (78%) saw reductions, a smaller proportion (13%) saw their rates rise, and 9% had no change. * Based on the housing market forecasts, the volume of residential mortgage credit outstanding is forecast to continue expanding. Growth is forecast at about 7.7% during2011 ($80 billion) and 7.3% in 2012 ($81 billion). A preliminary look at 2013 suggests growth of 7.0% ($83 billion). Call or email Sharie Marie Mortgage Team today to discuss how your mortgage.

Is it time to lock into a fixed rate mortgage?

"It’s one of the most agonizing decisions homeowners make: Do you go fixed or variable? Mortgage, that is.

The decision could end up costing – or saving – big bucks on what is often the single biggest purchase many will make. Research shows that, in the past, a variable-rate mortgage has been cheaper than a fixed-rate one.

But today’s market is different from decades past in two big ways.

“The spread between fixed and variable rates is extremely low by historical standards. Moreover, we can no longer rely on a long-term down-trend in rates,” said Robert McLister, a Vancouver-based mortgage planner and editor of theCanadian Mortgage Trends blog. “Given all that, the historical advantage of variable is less applicable today.”

It can be confusing for homeowners. Both interest and short-term mortgage rates are sitting at rock-bottom lows. But inflation is the wild card here. Statistics Canada reported on Friday that the core inflation rate has climbed to 2.2 per cent – its highest level in nearly three years.

Given the uncertain global economic outlook, the U.S. central bank has signalled it will hold its benchmark rate at close to zero through to mid-2013. And even though Canada’s economy is not faring too badly, the Bank of Canada is expecting to keep its key rate steady at 1 per cent until well into 2012.

So how do you make the decision? Let’s compare the two mortgage products.

Variable mortgages, which are based on the prime rate set by the central bank, fluctuate alongside the prime rate. And with rates slated to move sideways for the near future, there are still arguably plenty of savings to be had.

With a fixed-rate mortgage, homeowners lock in their mortgage rate for a specific period of time, the most popular being five years. People with a fixed-rate mortgage often pay a small premium for the security of knowing that their payments will stay the same. And since rates can arguably only rise from their current lows, locking in seems like a good call.

“The difference between today’s variable rate, which is 2.7 per cent on the street, and a good fixed rate, something like 2.99 per cent for a four-year, is remarkably tight at 29 basis points,” Mr. McLister said. That is equal to about one rate hike.

It’s a small price to pay for “knowing that you won’t get skewered by rising rates.”

Moshe Milevsky, a finance professor at York University and the often-quoted author of mortgage studies showing that variables tend to outperform, says that because interest rates are so low, the amount people will save from choosing variable over fixed will be lower in the future.

Like most mortgage experts, he believes a person’s circumstances should dictate which mortgage they choose. The decision should also be part of a larger financial plan.

“For people who are making their first purchase with a large amount of debt, small down payment and big risk, I would say not to take on more risk by gambling on floating rates,” Mr. Milevsky wrote in an e-mail.

On the other hand, people who are renewing with a substantial amount of equity, have a strong personal balance sheet, income statement, and other assets to fall back on in the event of a crisis, can go floating, he said.

Mr. Milevsky also suggests checking out a hybrid mortgage, which is partially fixed and partially floating. “By diversifying your mortgage debt you can reduce some of the worry.”

The good news, according to Mr. McLister, is that today’s low interest rates are favourable for all mortgage shoppers. “This is a great time to get a mortgage, if you are in the market for one,” he said. “You are most likely not going to get burned, no matter which term you take.”

Mr. McLister says these are the top considerations for people struggling to decide:

1. Financials 
Because variable-rate mortgages entail more risk, you need to know whether you are financially sound. Borrowers should have “good I.D.E.A.S.” That means your: Income should be stable, Debt should be reasonable, Equity in your home should be roughly 15 per cent or more, Assets should give you liquidity if cash flow gets tight and Sensitivity to risk should be low.

2. Spreads 
When the difference – or spread – between fixed and variable rates gets tight, variables lose some advantage. When the spread is less than one percentage point and we’re near the bottom of an economic cycle, fixed mortgages often have a higher probability of outperforming. Today’s spread between a five-year fixed and a variable is an astonishingly low half a percentage point.

Odds are better than 50/50 that we’re near the bottom of a rate cycle.

3. Breaking early 
People often break their mortgages early, for reasons that include refinancing, selling, divorce, or just changing to a mortgage with a better rate. One bank source pegged the average duration of a five-year variable to be about 3.3 years. Lenders penalize you for getting out of a fixed mortgage early. Penalties on variables are generally three months interest, whereas fixed mortgages can sting you with horrendous interest rate differential penalties. If there’s a chance you’ll refinance or break your mortgage, a variable may cost you less.

4. Flexibility 
Variables give you the option of changing your mind and locking into a fixed rate for free, which is useful if interest rates are not likely to rise in the near future. The problem is, locking in can be expensive because you’re forced to time the market, which is tricky. Also, you’re stuck with the lender’s “conversion rate,” which is often a fifth to a half a percentage point above its best fixed rate.

5. Alternatives 
The five-year fixed and the variable are not the only options; take a peek at shorter fixed-terms. Today, for example, you can find two-year fixed rates at 2.49 per cent, whereas most variables are 2.7 to 2.75 per cent, or higher. You can also diversify rate risk with a hybrid mortgage – one that’s part fixed and part variable.

6. Comfort of knowing 
If you can secure a fixed mortgage at a good rate, there’s less need to monitor the interest rate market. You know exactly how much interest you’ll pay. Variable-rate borrowers, on the other hand, must ride the rate roller coaster and tolerate some anxiety."

-ROMA LUCIW Globe and Mail Update

Contact a Sharie Marie Mortgage Team Professional today to discuss your options