As mortgage brokers, we see over and over that clients get themselves hung up on one particular number. That is the interest rate that they are paying on their mortgage. Clients often come to us seeking the lowest rate possible. Unfortunately, when the interest rates that mortgages charge are the sole focus of the borrower, they may ignore other important factors just to try to land with the lowest rate they can get. After all, everyone likes to be able to talk about how low the interest rate is on their mortgage at parties when chatting with their friends. You don’t want to be the person at the holiday party trying to explain that you didn’t take the lowest rate available because the lowest rate product included the bona fide sale clause, and you weren’t interested because of that. But rest assured, there are definitely situations where taking the lowest interest rate on a mortgage is not something you should do. Here are examples of some things you should keep in mind when it comes to deciding if the lowest rate product is the best one for you.
In This Article:
- What Effect Does the Interest Rate Have on My Payments?
- Wait. I’ve Never Heard of the ‘Bona Fide Sale Clause,’ but it Has Come Up A Few Times. What is That?
- What are Some Other Times When the Lowest Rate May Not Be the Best Choice?
- The Guidance of your Mortgage Broker
What Effect Does the Interest Rate Have on My Payments?
This is something that is really important to understand. How much do you actually save if you take the lowest rate? If we look at the mortgages with the bona fide sale clause as an example, depending on your lender, you may get an interest rate that is 15 to 20 basis points (bps) lower than a regular mortgage without that clause. What that looks like in real numbers is if you have a $500,000 mortgage with a 25-year amortization and the regular interest rate is 5%, you could have a discounted rate of 4.85% or 4.8% from taking the bona fide sales clause as part of the contract. This discount means that your monthly mortgage payment would be about $45 – $60 a month lower, but the discounted rate mortgage itself is far more restrictive than the non-discounted mortgage (more on that to follow). So if your lower-rate mortgage comes with restrictions applied to it or has penalty calculations that don’t go in your favour, you really need to consider whether the savings of around $600 a year are worth the loss of flexibility that came with that lowest interest rate that was available to you? For a quick way of comparing, for every $500,000 you borrow, the rule of thumb is that a rate that is discounted by 0.10% (10 bps) will save you about $30 a month. A slightly lower payment today could end up costing you thousands of dollars in the long run if it comes with a higher penalty to exit the mortgage, or restricts your ability to refinance and pay off other high-interest debt. Those limitations can be far more detrimental to your overall financial health than choosing a mortgage rate that’s 0.15% higher.
Wait. I’ve Never Heard of the ‘Bona Fide Sale Clause,’ but it Has Come Up A Few Times. What is That?
This is a term that you may have never heard before, and it bears a closer look because it is a very restrictive clause that can be in the fine print of your discounted low-interest-rate mortgage, and you may not even know it is there if it isn’t explained to you. The bona fide sale clause is a clause added to a mortgage contract where you are not allowed to end your mortgage early (i.e., before the term is up) unless you sell the property. This means no refinancing options are available to you. Some estimates project that up to 60% of Canadian mortgages are broken or refinanced prior to the end of their term. The reasons to break a mortgage can include things like wanting to get a lower interest rate, a change in your financial situation, the need to refinance to access home equity for a renovation, or other opportunities that have come your way. None of these are options available to you if you took the discounted rate and it was accompanied by a bona fide sale clause. The only way out of that mortgage before the end of the term is to sell your home. And they’ve thought of everything. The term bona fide means that the sale of your home has to be genuine. This means that it is a legitimate sale to an arm’s-length buyer, so no loophole of selling and then buying back is available to you. So make sure that you understand the fine print of your mortgage and if it includes the bona fide sales clause, know what that means, and if the restrictions associated with it are worth the small reduction in monthly payments that come with it.
What are Some Other Times When the Lowest Rate May Not Be the Best Choice?
You really need to remember that the rate that you pay is only part of the cost associated with how much your mortgage could potentially cost you. Understanding the terms and conditions, as well as any restrictions your mortgage has, can potentially save you significantly more than the savings you get from choosing the lowest rate. Here’s a list of times when this may be the case:
- You may want to break the mortgage before the term is up. Regardless of whether this is for moving or refinancing purposes, you need to understand how your mortgage behaves in this case. A no-frills, low-rate mortgage can make something like refinancing at the worst impossible and at the best cost you thousands of dollars in penalties.
- Does the lowest rate come with big interest rate differential (IRD) penalties? Using the IRD calculation for a penalty when you break your mortgage early can cost you thousands of dollars compared to the $50 or $60 a month you save by taking the lowest rate mortgage with the highest penalties associated with it.
- What are your lenders’ prepayment privileges? Prepayment privileges are important because they can potentially save you huge amounts of interest over the life of your mortgage without triggering penalties. Many ultra-low-rate mortgages have lower prepayment options associated with them, so while you may save on your monthly cost, the total amount your mortgage costs you is significantly higher.
- What about the service from the lender? Many no-frills plans have slower underwriting times associated with them; they may not work for self-employed individuals or simply lack flexibility unless your documentation is perfect. If any of these things carry weight in your decision-making, the lowest rate products may not be a fit for you.
- What if you expect interest rates to drop? Since so many of these low-rate plans come with limited options for portability, the ability to blend and extend your rate and term, or switch lenders, you are going to be stuck even if your ‘low rate’ plan is actually costing you more than you could get a new mortgage for if rates do go down.
The bottom line when it comes to the choice to enter into one of the discounted low-rate plans that has a restrictive contract associated with it is that you need to be prepared to live with that decision for the duration of the term of your mortgage. Ask yourself if you are certain that there will be no reductions in interest rates in the next three to five years, that you won’t be moving and won’t want to refinance, you don’t need to have flexibility with your payment options, and you’re okay with either being fully locked in or facing restrictive penalties if something in your life changes. If the answer to any of these questions is ‘no’, then you really need to ask yourself if the lowest rate is the way that you should make the decision related to your mortgage.
The Guidance of your Mortgage Broker
As is always the case, now is the time to highlight that we are talking about dealing with an independent mortgage broker, like the team at Strata Mortgages, and not talking to the mortgage specialist at your bank. When you deal with an independent mortgage broker, they are able to provide you with many options from a wide variety of lenders and advise you as to the pros and cons of all of the offerings. The specialist from the bank will be limited to whatever products their employer provides, so the options are limited, and the best option for your unique situation may not even be available on the product shelf they are able to access for you. When you talk to the specialist at the bank, they are often paid based on the rate that they ‘sell’ you, so in this relationship, it is up to you to negotiate your own rate, and often, you are working against the specialist who is supposed to be helping you because they make more money selling you a higher rate. And while I am on this topic, as another fun fact, there is no requirement that a mortgage specialist at a bank is licensed, and they don’t have any independent regulator overseeing things like their individual ongoing education and training. Mortgage brokers in Ontario are licensed and regulated by the Financial Services Regulatory Authority of Ontario. Why would this matter? The process of licensing with a regulatory body ensures that the individuals who hold the license meet the required standards of education, experience, and suitability, and that there is an outside authority holding them accountable for their actions. Being a licensed independent mortgage broker carries a fiduciary duty to you as the client. Your mortgage broker is legally and ethically required to provide full disclosure and always act in their clients’ best interest. An employee at the bank branch is not bound by this same level of fiduciary duty and is often driven by pressure from their employer to put the interest of that employer, the bank, ahead of the client’s best interest. I will end my aside here on why a mortgage broker is a far better option than a bank’s mortgage specialist with this simple question: Who do you want negotiating your mortgage? Someone who works for you or someone who works for the lender, trying to get you to pay them interest? Now that we have that out of the way, your mortgage broker will be able to help you determine why the lowest rate may not make the most sense for you. If you are thinking of moving, and you are considering something like accessing equity for a home renovation or for debt consolidation, want to be able to easily switch lenders at your renewal, or a host of other reasons why taking the restrictive lowest rate option, we can help provide the best solution. One of our mortgage brokers can walk you through how the penalties included could end up costing you thousands of dollars more than the small savings that are associated with taking the mortgage with the rate that is discounted by a few basis points. Talk to the team at Strata Mortgages today and see how they can help guide you through the process of deciding what the best mortgage for you and your unique situation is.
