Why the Mortgage with the Lowest Rate isn't Necessarily the Best Mortgage
Searching for a mortgage is about a lot more than simply finding the mortgage with the lowest rate. If you were searching for a new TV set, you wouldn’t just buy the TV set with the lowest price. You’d consider other factors like screen size, resolution and refresh rate. So, why do so many of us make this same mistake when it comes to our mortgages? We search for the mortgage with the lowest rate, ignoring other important factors.
Mortgages are more complicated than ever these days. Unless you ask the right questions and have a competent mortgage broker on your side, you could end up in a mortgage that’s not right for you. As I like to say, the mortgage with the lowest rate can help save you hundreds, but the wrong mortgage can cost you thousands.
If there’s a good chance you could have to break your mortgage in the next year or two, it might be worth signing up for a mortgage with a slightly higher mortgage rate, but a lower overall mortgage penalty. Although you could end up paying more right now, you’re likely to save money in the long-run.
This is just one example of when the lowest rate doesn’t always make sense. Here are some other factors to consider when searching for a mortgage – what I like to call the “3 mortgage P’s.”
1. Mortgage Penalties
It’s no coincidence that mortgage penalties are number one on my list of factors. Mortgage penalties are such a crucial factor (quite possibly more important than the rate itself), yet many of us don’t ask about them when shopping for a mortgage.
Now, I know what you’re thinking. There’s no way I’m going to break my mortgage. Why should I care about mortgage penalties? While, you may think you aren’t going to break your mortgage, unfortunately, nobody has a crystal ball. Life has a way of throwing curveballs at us. You could get sick, lose your job or decide to relocate to accept a job promotion.
The bottom line is that it’s hard to predict what the future holds. Wouldn’t you rather have a mortgage that’s flexible with a low penalty, rather than one that’s going to penalize you to the tune of five figures? I know, I would. You might end up turning down a lucrative job promotion, all because your mortgage penalty would be too high to sell. That’s no way to make an important decision about your career.
If you think there’s a chance you could break your mortgage during its term, consider signing up for a variable rate mortgage. With a variable rate mortgage, you’ll typically only pay three months’ interest for exiting out of your mortgage early. If you don’t like the thought of mortgage rates going up during your term, a fixed rate mortgage can make sense, just be sure to ask how the penalty is calculated. You’ll want a mortgage penalty that’s calculated based on the lower discounted rate, not the higher posted rate.
2. Prepayment Privileges
Is your goal to pay off your mortgage sooner? Then you’ll want a mortgage that allows you to make extra payments without facing hefty penalties. As its name suggests, prepayment privileges are extra payments you can make upon and beyond your regular mortgage payments. Best of all, you won’t pay a penalty for making them.
Mortgages come with three main types of prepayment privileges: increasing your mortgage, doubling up your payment and making lump sum payments. Prepayments are helpful, since unlike a regular mortgage payment that goes towards interest and principal, prepayments go fully towards principal. That means if you make a prepayment of $1,000, it reduces your outstanding mortgage balance by the full $1,000. It doesn’t get any better than that!
By taking advantage of prepayments you can shorten your mortgage amortization period (the length of time it takes to fully pay off your mortgage) and potentially save yourself thousands of dollars in interest over the life of your mortgage.
3. Porting Your Mortgage
If you do end up needing to move later on, it helps if your mortgage is portable. With a portable mortgage, you can take your mortgage with you without facing hefty penalties.
Going back to our earlier example, let’s say you’re working in Toronto as a financial analyst and you get a promotion offer in Vancouver with a $15,000 pay raise. If your mortgage is portable, you can sell your home in Toronto and buy a home in Vancouver, all without paying a penalty out of pocket (upon lender approval, of course).
If you’re purchasing a more expensive home and need more money, many lenders let you “blend-and-extend” your mortgage by taking out a new mortgage for the extra amount you need to borrow to complete the purchase.
Be sure to consider these factors and others when shopping for a mortgage. Remember, mortgage rate is one factor to consider, but when considered alone, it can end up costing you in the end.
Sean Cooper is an independent mortgage broker and the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians.