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when you thought you had your mortgage finances in order, interest
rates take a nose dive. Now you're wondering if you should opt for
early renewal and take advantage of the new low rates. Hmmm. Sounds
tempting, but hold on a minute. You need to examine your financial
goals. The cost of mortgage debt is very high, especially in a low inflationary environment, such as now. The number one way to attack that mortgage debt is to pay your mortgage off quickly. If this is one of your medium to long term goals, it makes sense to apply any surplus cash directly to your mortgage. If your objective is to lower your mortgage payments to increase your immediate cash flow, breaking your mortgage contract to renew early is not necessarily the best (or only) option available. If you have an open or a variable rate mortgage, you're on easy street; you can lock-in to a fixed rate mortgage at the low rate without charge. But if you have a closed or fixed-rate mortgage, you will have to look carefully to see whether it pays to renew your mortgage early. Does it Pay? And does it pay? Yes and no. When you break your mortgage contract to renew your mortgage at a new rate and a new term, you are faced with a prepayment charge to reimburse your financial institution for the lost interest income. As a basic rule of thumb, the prepayment charge is based on three months interest or the interest rate differential (that's the difference between you present mortgage rate for the balance of your term and the current rate you want to take out), whichever is greater. If your mortgage is insured by the Canadian Mortgage and Housing Corporation, you pay a maximum penalty of three months interest after the third anniversary date of the interest adjustment period, or after the third anniversary date from your most recent renewal. The amount of the prepayment charge will tell you whether or not you should renegotiate your interest rate. Generally speaking, the shorter your remaining term - ideally less than a year - the smaller the penalty, and the more attractive early renewal becomes. On the other hand, the longer the term left on your mortgage, the greater the prepayment charge, which makes early renewal less desirable. Weigh Pros and Cons Regardless of the size of the prepayment charge, be prepared to pay it out in one lump sum. Assuming that you have that money readily available in the first place, you will have to take it out from another interest earning investment, losing that income altogether. You have to weigh what you will lose with what you might gain. If you don't have the money to pay the prepayment charge, you will have to borrow it. That will likely mean refinancing your present mortgage, assuming you have sufficient equity in your home to cover the prepayment charge. But then you are no longer renewing your mortgage; you are taking out a new mortgage or amending your existing one. That adds to your costs because you will have to pay for legal, appraisal and registration fees if you refinance. This is not the way to pay down your mortgage quickly. Again, you have to decide if the cost of renewing early is greater than the money you stand to save. If you feel that you will come out ahead, then think about what term you should renew at. That really depends on interest rates, and whether you think they are as low as they are going to get. If you think rates have bottomed out, lock-in for the long-term. Otherwise, keep the mortgage open until you see rates on the rise, and then go long-term. An open mortgage is also a good idea if you are thinking of selling your home in the near future. If saving money on your mortgage is the goal here, try to keep your payments the same; you will save even more money by paying more towards the principal. Or you could make lower payments - to ease your short-term cash flow - if your objective is to keep more money in your pocket. Review all Options But before you go through the process of early renewal, review all your other options first. As you can see, depending on your prepayment charge and other costs, refinancing might not make a huge difference to your mortgage. In some cases it can cost you money. So go back to square one and ask yourself if you have exhausted all the other opportunities to save money on your mortgage. For example, if you actually have the cash to cover the prepayment charge, you could take that money and use it to pay off a portion of your mortgage. This will decrease your principal and save you money in the long-term. You can continue to make your pre-payments each year. (You are allowed to pay from 10 - 15 per cent off your mortgage annually without charge or administration costs). Still another way to save money on your mortgage is to pay your mortgage off faster with weekly or bi-monthly payments. Before you consider renegotiating your mortgage, make sure you are doing everything possible right now to reduce the cost of your mortgage. Then, if there's room to save extra money, see if early renewal is going to pay off for you. When It Doesn't Pay $100,00 mortgage ......................... 25-year amortization $97,620.32 balance ....................... 5 Year Term at 11 per cent Current rate for remaining term 8 per cent 29 months left in term to renegotiate Prepayment Charge: 3 month interest ............................. $2,611.86 Interest rate differential ................. $6,198.87 When It Pays $100,000 mortgage ........................ 25-year amortization $95,677.42 balance ........................ 5 Year Term at 11 per cent Current rate for remaining term 8 per cent 8 months left in term to renegotiate Prepayment Charge: 3 month interest .............................. $2,559.88 Interest rate differential .................. $1,758.89. Article:
It's All In The Delivery
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