Tuesday, November 06, 2012

How Much is Enough Mortgage Friction?

By Mark Kerzner, President, TMG The Mortgage Group Canada Inc.

A mortgage consumer recently described the cost and work involved to switch lenders, either at mid-term or at maturity, as "mortgage friction." This is an interesting comment. If there are savings to be had, how much “friction” would be acceptable? The old adage, "you can't get something for nothing" might apply here.

We hear countless stories of people willing to pay hundreds of dollars in cancellation fees to switch cell phone, cable or even home security providers yet when presented with an opportunity to save thousands of dollars, some mortgage holders don’t seem to want explore their options.

When you add in the fact that banks routinely charge higher interest rates to existing clients than they do to new ones, mortgage holders may be better served by shopping around at renewal time. Clearly, the best way to shop for rates is by using the services of a mortgage broker, yet 73% of Canadians choose not to, even though, on average, the ones who did, saved 19 basis points on their mortgages. Those who renewed or renegotiated with a mortgage broker reported an average rate decrease from posted  of 1.4 basis points, compared with 1.0 points among all renewers.

While 48% of first-time buyers used a mortgage broker only 27% of those refinancing and 21% of those renewing used one. At renewal, 88% of consumers remained loyal to their lender. So, with a discrepancy of up to 40 basis points at renewal, why are so many staying loyal to their existing lenders?

It might make sense to stay with your original lender, but not always. After all, your mortgage broker offered you the best mortgage and interest rate at the time of purchase. But some lenders such as FirstLine have now left the market, while others, including your existing lender may have changed their pricing strategies.

To know whether changing lenders is right for you it is vital to understand the process and the costs. The number one cost or "friction" is the need to re-qualify. Most lenders will automatically offer their good customers a renewal. If you need additional funds or plan on transferring or switching to another lender, that new lender will first have to re-qualify you.

When you switch lenders you or the new lender will request a payout statement -- in many cases your mortgage broker can assist you with this.  There may be a discharge fee, perhaps a penalty on your existing mortgage and an appraisal may be required. In some instances the new lender will pick up the cost of legal fees and appraisal costs.

There are no penalties when a mortgage reaches maturity, however, if you transfer or refinance your mortgage prior to maturity there may be contractual penalties. The most common are the Interest Rate Differential (IRD) for fixed rate terms and three months interest for adjustable/variable rate mortgages.

So let’s assume that financially it makes sense to switch –now let’s look at the numbers. Assuming a mortgage balance of $250,000 on a 5-year fixed rate and an amortization of 25 years, here is a comparison of three scenarios:

$250,000 mortgage, 5 year fixed, monthly payments, 25 year amortization
(numbers are used for illustrative purposes only)

     Rate        Payment          Int. cost (term)       Balance (end of term)           Increase cost over #1
1   3.19        $1,207.63       $36,918.05           $214,460.25
2   3.38        $1,232.40       $39,167.47           $215,223.47                         $2,249.42
3   3.59        $1,260.09       $41,658.85            $216,053.45                        $4,740.80


The savings identified above are after tax dollar savings, which can be significant.

It is worth it to consult with a mortgage broker. Reviewing options with a broker does not negate an offer to renew with your existing lender.  In the end the broker may advise you to stay where you.  However, it’s worth finding out whether or not you can financially benefit by switching.

Cost and rate aside, mortgage brokers can lessen the “friction” by facilitating the process on your behalf. With a single application and credit review they can navigate the market on your behalf, assessing options from multiple lenders. They will advise on product features including prepayment options and penalty calculations to match you with the right product for your unique circumstances. 

Call your local mortgage broker today.

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