Tuesday, July 23, 2013

Renegotiating your mortgage agreement

It’s a familiar story. You buy a house and lock into an interest rate for a five-year mortgage term. Then something changes in your life midway through the term and the current mortgage doesn’t meet your needs. Or mortgage rates have gone down substantially and you would like some interest rate relief, so you consider renegotiating the mortgage agreement. However, there will be a cost and that cost will most likely determine whether you renegotiate or not.

The first step is to decide what your new needs are. Do you have to move because you’ve been transferred? Do you simply want to renegotiate to get a lower interest rate to ease your monthly payment? Do you need to make some significant home improvements? Have you accumulated debt and would like to consolidate? 

If you opted for a variable rate mortgage, the prepayment penalty may be the least costly. If, however, you opted for a fixed rate, the calculation is a bit more complicated. And different lenders offer different terms and conditions.

Here’s how it works. There are two types of mortgages – fixed and variable-rate mortgages.  For the most part, variable-rate mortgage charges are three months interest. Fixed-rate mortgages have different rules. They use the interest rate differential. Different lenders have different ways of making this calculation but basically it’s the lost interes,t calculated at the current contract rate, minus the market rate at the time the penalty is calculated, for the remaining term.

If at the time of the calculation, the market rate is higher than your contracted rate, then the lender will only charge three months interest penalty. After all, the lender stands to make more money at the higher rate.  However, if the rate is lower, then you get hit with the rate difference.

Some lenders are pretty clear with their calculations, others however are not.  You’ve no doubt heard about penalty fees in the thousands of dollars. Here’s how that happens. Let’s say you have a contracted five-year rate at 2.99% but you want to break it in the second year.  Some lenders won’t use that rate to calculate the differential but will use their posted rate, which is substantially higher.  A posted rate of 5.14 per cent, for example, would create an interest differential of 2.15 per cent. If your mortgage is in the $300,000 range, then the penalty will be in the $10,000 range. That’s a hefty sum.

There are also options to help reduce those prepayment charges. Many mortgage agreements allow you to prepay a certain amount without triggering a charge. You might consider prepaying a portion of the mortgage before renegotiating so your charge is calculated on the balance. But beware; some lenders have rules on how close to the date of renegotiation you can make those prepayments.

If you’re renegotiating because you’re moving, you can avoid prepayment charges by porting the mortgage, which means you take your existing interest rate, terms and conditions to your new home.

If you’re renegotiating to take advantage of lower interest rates, some lenders will allow you to blend- and-extend the mortgage until the end of the term. Your old interest rate gets blended with the new term’s rate. You will probably get charged an administration fee.

There may be benefits over the long term to renegotiating your existing mortgage if it fits with your overall financial goals. It’s always a good idea to get advice from a mortgage broker who can offer options and solutions.

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