🙋6 Things You Should Know When Applying For A Mortgage🏠
All mortgages are not created equal, and making the wrong choice can end up being a costly or frustrating decision. This is exactly why you should never choose a mortgage based on rate alone. Trying to save a few hundred dollars per year on rate can sometimes end up costing you thousands down the road.
An educated mortgage borrower is a smart mortgage borrower, and smart borrowers will end up saving the most money long term.
And saving money is what it’s all about!
It’s great to secure the lowest rate around, but the lowest rate doesn’t always end up saving you the most money. The terms and conditions can be more important than the rate itself, as they can end up costing you more down the road if you don’t have the proper guidance throughout the process.
This is why choosing the right person to handle your mortgage for you is so important. There are many in the role of mortgage advisor who operate more as order takers than anything else. There is a big difference when dealing with a true mortgage professional vs. an order taker. You have a lot of money riding on this, so guidance from a true mortgage professional throughout the process is of paramount importance for those looking to maximize their savings long term.
Not all mortgage advisors will be that quick to point things out. They may gloss over certain terms or restrictions… or may not even mention them at all. To ensure you’re getting the mortgage that is best suited to your needs, here are six things to consider before signing on the dotted line:
- Rate float down policy
- Penalty to break
- Prepayment privileges
- Collateral or standard charge
- Bonafide sale clause
1. Rate Float Down Policy
If rates drop after the lender has issued you a mortgage commitment, you’ll want to know what their policy is. Don’t automatically assume you will get the lower rate. Most lenders will allow you a one-time rate float down (drop) before closing. If this is the case with your lender, you may want to hold off on the request if your closing is still a couple months away providing that rates are stable or in a downward trend.
There are some lenders who allow unlimited rate float downs, while others may not allow them at all.
Rates can typically be dropped up to seven days before closing, or even closer.
Getting the lowest rate at the time of application is one thing, but that doesn’t always end up being the lowest rate at closing.
2. Penalty To Break Early
There are many people who tend to fluff off the penalty as they don’t intend on breaking their mortgage early. Instead, they may choose a lower rate over a more consumer friendly penalty. But circumstances often change. People don’t plan on getting divorced either, yet it happens far too often.
There are many reasons why people might break a mortgage before the end of their term, some are not that pleasant:
Bought a new home
Switch to a lower rate
Take out equity
Lower mortgage payment
Separation / Divorce
Life can be hard to predict, and sometimes it can throw you a curveball. While many don’t intend on breaking their mortgage early, more than 60% of people do. The majority of them didn’t plan on breaking at time of setting it up.
The penalty to break a variable rate mortgage is three months interest in most cases. However, some lenders will calculate this based on prime rate, while others will calculate it based on your actual mortgage rate. On a $500,000 mortgage at prime -1.00%, the difference in penalty would be $1,250. This difference remains the same as rates change.
While variable rate penalties are predicable, fixed rate penalties are not. The penalty to break a fixed rate mortgage can be as much as 900% higher with one lender vs. another. This could mean the difference between a $5,000 penalty or a $45,000 penalty. There isn’t always this much difference, but I just wanted to illustrate how large the difference can get.
This is why penalty is a major point of concern when choosing a mortgage, particularly if you end up with a harsher penalty lender. Among the lenders with the harshest break penalties are the big banks. But they aren’t the only lenders to watch out for, so it’s best to choose a broker who is going to be up front with you about this.
On a $500,000 mortgage, a 0.05% difference in mortgage rate works out to roughly $1,250 over a five year term (exact number will fluctuate depending on the rate). A small difference in rate would not make much difference to your pocketbook at the end of the day. But a harsh fixed rate penalty can be a crushing blow to your finances.
3. Prepayment Privileges
If paying your mortgage off faster is important to you, then you’ll want to choose a lender with flexible prepayment privileges. With some options, you might be limited to paying only 5-10% per year towards your mortgage. They may also limit you to a single lump sum payment per year.
For example, a lender might allow you to prepay $100,000 per year, but if you make a lump sum payment of say $4,000, then you may not be able to make another one until the following year. Others will let you make as many lump sum payments as you wish, as long as they fall on a scheduled payment date and don’t exceed the maximum annual limit in total.
4. Collateral Charge or Standard Charge
A mortgage can be registered as either a collateral or a standard charge. This can have a direct impact on your cost to switch lenders at the end of your term. With a standard charge mortgage you can shop around and switch to another lender without any cost to you other than the discharge fee from your current lender (roughly $300 in Ontario).
With a collateral charge mortgage, there would also be a legal fee of approximately $800 and appraisal fee of approximately $350. There are some lenders who will cover some, or even all of these costs for you, however the rate can be marginally higher.
Fixed rate mortgages are always compounded semi-annually, regardless of whether you’re dealing with a major bank, monoline lender, or credit union. Variable rate mortgages on the other hand can be compounded either monthly or semi-annually.
What’s the difference?
Let’s take a look at how each compounding method affects the overall cost of the mortgage. We’ll use a $500,000 mortgage at 5.00% amortized over 25 years as an example.
Monthly payment with monthly compounding: $2,922.95
Monthly payment with semi-annual compounding: $2,908.02
A difference of $14.93 per month.
Once you factor in the difference in your balance at the end of your term, the cost of having monthly compounding would be $1,377.08. That’s IF there is no change to prime rate over the 5 year term.
If you don’t consider the compounding, then you could be looking at two otherwise identical mortgages. Yet one will be at a higher cost than the other.
6. Bonafide Sale Clause
There are some mortgages that are fully closed for the term due to a bonafide sale clause. What this means is that you can’t pay the mortgage off in full at any time during the term unless you sell your home. It also means you cannot switch or refinance with a different lender mid-term. This restriction does not prevent you from selling your home. At the end of your term, the restriction is meaningless.
There are some who become so overly focused on getting the lowest mortgage rate that they don’t even consider the terms. It’s great to save on the rate, but being overly rate focused can end up costing you more over the term.
If dealing with the lender directly, they aren’t necessarily going to point out these differences, particularly if they don’t have anything else to sell you. Even some brokers may not be that quick to explain them to you. The only way to ensure you’re informed is to ask the questions directly. Or even better, come to us for your mortgage and we’ll ensure you know all the details, while giving you a better experience than you’ll get anywhere else!