Aug 13, 2018
I’ve seen a lot of borrowers make a lot of mortgage mistakes in my 11 years in the business. Mortgage shoppers tend to follow similar patterns. They “overstress” mortgage features that matter minimally and they “understress” contractual terms that matter a lot.
This story is meant to deter you from common mortgage mistakes when making your decision. It illustrates which mortgage factors impact your borrowing costs the most so that you can focus on the terms that make a difference.
Mortgage shoppers tend to (but shouldn’t!)…
1. Overstress about prepayment privileges
Only Canadians pay more than required on their mortgage, according to Mortgage Professionals Canada. Canadians make lump-sum prepayments totalling just 1% of their mortgage each year. Given that the average mortgage is $258,000, prepayments equate to $384 average interest over a typical 5-year term. Most folks are far better off in a mortgage that has smaller prepayment privileges but a lower rate. Other things equal, a 1/10th percentage-point-lower rate would save over three times more interest on that very same mortgage.
2. Understress porting flexibility
Canadians move every on average. The typical closing time frame on a new home is about 45-60 days. Yet, many low-rate lenders offer just 30 days or less to port your mortgage without penalty. If you move and don’t have enough time to port, you could face a costly penalty (minimum 3-months’ interest, up to 3% or more of your mortgage amount). If there’s a chance you’ll move, it seldom makes sense to save 1/10th of a percentage point on the rate ($1,224 on the average mortgage) when your penalty could be one and a half to four times that amount on a 5-year term.
3. Overstress the risk of a variable rate Variable rates outperform fixed rates over time. That’s a well-known fact. They also tend to have lower prepayment penalties than fixed mortgages. What many forget is that floating rate mortgages don’t need to involve payment risk. Roughly half of major lenders sell . That way, you can enjoy the benefits of a lower upfront variable rate without worrying about soaring rates eating into your monthly cashflow.
Tip: be aware that rising rates will cause you to (temporarily) pay off your mortgage slower if you have a fixed-payment variable rate. But when you renew the mortgage your payment typically rises a bit to keep your original amortization on track.
4. Understress blend-and-increase features
Roughly half of borrowers renegotiate their mortgage before maturity. For those who need to increase a closed mortgage, renegotiating early can be costly. Some lenders don’t allow increases at all without penalty. Others will require you to pay an uncompetitive interest rate on the increased loan amount, or even apply higher rates to your entire remaining balance! If there’s a chance you might need to refinance or buy a new home with a bigger mortgage, be sure to pick a lender that: A) has excellent publishedmortgage rates, and B) allows you to increase your mortgage at its best rates without undue fees or penalties.
5. Understress penalty calculations For most people, choosing a lender without considering prepayment penalties is economic self-injury. On fixed-rate mortgages, for example, big bank penalties can easily be two to three times larger than non-bank lenders. On variable-rate mortgages, some deep-discount lenders charge penalties equalling 3% of principal instead of the standard 3-months’ interest. In each of these cases, the penalty can be over three to four times the interest you’d save with a slightly lower rate. Unless it’s your last mortgage or your balance is low, be penalty aware.
6. Overstress the importance of a bank fund most of the mortgages in Canada and have trusted brands. But they’re seldom worth paying materially more for. We already talked about bank penalty risk. But that aside, with all the competition out there, bank loyalty seldom gets you the lowest rate in the market. That’s on top of the fact that bank reps only sell their own branded mortgages and rarely advise you of better deals elsewhere. These days, you can do everything online or by phone so you don’t need a branch. Mortgage lenders will electronically take payments (and prepayments) from whatever bank account you stipulate, making almost all lenders “convenient.” In short, keeping all your finances at one institution isn’t worth the extra cost of a higher bank rate.
7. Understress the importance of comparing rates Canada has more than 400 lenders selling mortgages. There’s over a two-percentage-point difference between the lowest 5-year fixed rate and the highest, and over a 0.35 percentage-point difference between the lowest 5-year fixed rate and the average. Each additional 1/10thpercentage point you pay costs you $472 more over five years, for every $100,000 of the mortgage. Yet, most people spend more time researching a vacation than researching the best mortgage. There are few more objective places to research mortgage rates than a reputable rate comparison site that scans the entire market. Use these sites to your advantage. Even if you’re inclined to use a particular broker or bank, keep them honest by making them contrast their offers against what you find online.
8. Overstress standard charge mortgages (vs. collateral charges) Collateral charge mortgages got a terrible reputation following this . But they’re vastly misunderstood. The main disadvantage of a collateral charge is that it could cost you $1,000 to switch lenders (which you might want to do to get a lower rate at maturity). But worrying about $1,000 in potential switch costs is trivial if those costs are offset by a better rate or features at the new lender. Why would you care about paying $1,000 to switch lenders if you’re saving $2,000 on the rate, and/or getting the low-cost line of credit you need (note: all home equity lines of credit are collateral charges). That’s not to mention that 4 out of 5 borrowers stay with their lender at renewal, making switch fees less consequential.
Tip: some lenders will pay or discount your collateral charge switch fees, making the collateral vs. standard mortgage debate moot in some cases.
9. Understress restricted mortgages What many lenders giveth (low rates), they taketh away by way of restrictive mortgage contracts. It’s now common to find lenders that restrict your ability to:
Other lenders simply charge costly penalties for early termination.
Paying more for features you’ll never use doesn’t make sense, but we can’t always know our future needs. Most of the time, it doesn’t pay to save 1/10th of a percentage point on the rate and be ruined by restrictive clauses.
10. Overstress small rate differences
Some people will literally choose a lender or broker based on a 0.01 or 0.02 percentage-point rate difference ($1 or $2 a month in payment on an average mortgage). On rate comparison websites, the first and second-best mortgage rates are often less than 0.03 percentage-points apart on average. Yet, the lowest-rate provider gets over twice as many customers. For the reasons above, it virtually never makes sense to choose the lowest-rate mortgage simply because the rate is lower. When the rates are close, focus on the mortgage terms, conditions and service/advice you receive, so these things don’t haunt you after your mortgage closes.
Robert McLister tracks daily for RateSpy.com and is the founder of . You can follow him on Twitter at
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