Dilip and Geeta purchased their first home in 2012. They went to their Big 5 bank who had a 5 year fixed rate of 4.79%, but offered them a ‘discounted’ rate in the mid-3’s. This summer, they finally got fed up hearing how their friends were all paying closer to 2.0% on 5-year variables. They went to their bank to ask about switching to a lower-rate variable.
“Sure, we’d be happy to save you some interest. You could reinvest the savings in an RESP for your child,” said their bank’s financial advisor. Geeta and Dilip were thrilled.
“There will be a small penalty to break your existing mortgage,” said the bank advisor.
“Fair enough,” Dilip said. “The savings over the rest of the term of our mortgage will still be worth it.”
“How much will the penalty be?” asked Geeta.
“Well, in order to determine that we have to calculate the interest rate differential between your current rate and what we can offer you for a better rate today. I see that your current rate is 3.24%, and your discount rate was 1.55% (4.79% – 3.24%), and your current balance is $550,000 with 2 years left on your term… So that’ll just be $21,450.00 in prepayment charge.”
Geeta and Dilip both gasped.
“Oh, and there’s just a little reinvestment fee because you’re prepaying your mortgage during the first term.”
“What if we go to another institution?” asked Geeta?
“Not a problem,” said the bank advisor, “there’ll just be a little assignment fee added as well.”
Geeta stood up from the comfy green armchair in the advisor’s office. “Let’s go Dilip”, she said softly, “there’s no way we’re going to save any money here.”
Sadly, this is all too common. If Dilip and Geeta had of come to MorCan Direct for their mortgage, we could have gotten them a fixed rate mortgage from our non-bank lenders who don’t use any sleight-of-hand “discount rates”. So if they needed to break the mortgage later, whether to take advantage of a better rate or to withdraw some equity for another investment (like an RESP), the prepayment penalty would “still be worth it” just like Dilip thought.
Unlike with the banks, with us and our lenders what you see is what you get!
Disclaimer: Some names and identifying details have been changed to protect the privacy of individuals.
