We are staring the spring housing market straight in the face. If the last two years are any indicator – the banks and mortgage interest rates offered will provide deep discounts and the competition will be fierce to gain market share. This means there is a hidden opportunity for existing mortgage holders – the option to save thousands with an early mortgage renewal. Here is how you can take advantage and pocket a stash of cash.
Can I Save Money With An Early Renewal?
The short answer to that question is that it depends on the numbers. Every mortgage scenario is unique to the amount owing, the time left to maturity of the term, and your existing lender’s contractual obligation regarding an early pay out penalty. We just have to complete the math exercise to see if you will benefit.
Another consideration and one most Canadians haven’t experienced yet is if the mortgage they hold with their bank is registered as a Collateral Charge. This has additional restrictions and costs to consider that we will not cover in this post.
How One Couple Saved Over 2K
Here is a scenario that I come across often. “Ben & Geri” had 250K left on their existing mortgage with another 18 months until the term of their 5 year fixed mortgage matured. They held a 3.89% interest rate that was subject to an early renewal penalty of what is called an Interest Rate Differential. This is effectively the difference between what the bank can lend these funds out for today versus what they are charging you for the remainder of the term (a caveat here: the big banks use a Posted Interest Rate to calculate this making it more difficult to implement this strategy).
We completed the calculation and confirmed that their payout penalty was going to cost them $1,500. I then found them a mortgage with a variable rate of 2.35% for a five year term that provided a monthly payment of $1,100. Their existing mortgage payment was $1,300. Over the next 18 months – this provided them with an additional $3,600. Minus the early payout penalty and they were still ahead by $2,100.
The strategy still works moving to a fixed interest rate mortgage however you are only ahead by just over $600 so it is not as effective. There are also cases where the difference is much greater.
How Do I Know If I Can Save Money?
There are a number of quick steps you can take to determine if you are a candidate of this money saving strategy:
1) Determine your mortgage scenario – Take the time to dust your off your annual mortgage statement. Write down the amount you are owing today (or as close as possible), the interest rate you are paying, and read over your original mortgage contract to get an idea of how your early payout penalty is calculated (you may need a magnifying glass for that last one).
2) Crunch the numbers – If you are subject to a three month interest penalty (variable rate mortgages) then it can be a reasonably simple exercise of looking at your amortization schedule, finding the interest component and multiplying that number by 3 for a close estimate.
If you have a fixed rate mortgage then more often than not it will be a greater of the three month interest penalty or the interest rate differential that we spoke about earlier.
The mortgage contract may hold the formula for the IRD calculation. If so, follow along and you will again come to an estimate of what you will have to pay if you were to break your mortgage early.
3) Get a new mortgage offer – Now is the time to get a preliminary idea of what type of mortgage payment you will be subject to on early renewal. Shopping the market is always a good idea. Speaking with an Independent Mortgage Broker will ensure that you are getting the lowest rates as well as avoiding any contractual limitations that come along with the big bank’s product.
You will at this point be able to see the difference in your monthly payments.
4) More math – Now comes the final considerations and number crunching. We take the difference between the payments, multiply by the remaining months in the term, and minus the penalty from the total amount. This will give you a very close idea of how much you will save by making an early change in your mortgage.
Note that this is not an exhaustive covering of this topic.
There can also be market factors that can change your penalty very quickly. Discounts can be negotiated on the total amount of the penalty and in some instances incentives are available to cover some of the costs of moving your mortgage to another institution.
It is all part of being diligent in managing your personal financial house while working with competent professionals that will assist you in saving your hard earned money.
So now it is your turn. Take the time to figure out if you are a candidate for an early mortgage renewal. Do the math and check it again. You may just be surprised to find yourself a couple grand richer.
Michael is a passionate educator about mortgages, personal credit, and finance. You can find him at Mortgage Truth.