I’ve been away for the past little while dealing with a death in my wife’s side of the family. Thanks to everyone for your notes of support — it is truly appreciated. Today’s post is a guest contribution from Mike of Four Pillars. Regular programming will resume shortly. Over to Mike…

I recently did an analysis on my mortgage to see if it was worthwhile to refinance it. According to my original analysis, it wasn’t since I would be more or less breaking even. If I did end up making any money it would have been because of a good call on interest rates rather than the refi itself. As an interesting side note – we found out the termination fee from both the mortgage company and our mortgage broker. The mortgage broker’s termination fee was $300 higher which I guess would be their commission for ‘brokering’ the new mortgage. Always check with the mortgage company for the details.

Mr. Cheap referred me to one of his earlier posts where suggested that a cheaper way to refinance was to make use of any pre-payment room to lower the termination fee. He points out that you can borrow the money, pay down the mortgage and then get a new mortgage for the original amount and use the cash difference to pay off the loan. Since the loan would be very short term, the interest should be minimal.

Let’s look at a simple example:

Joe has a mortgage for $150k at 5% interest, 5 year term and he is 2 years into the mortgage. He owes $100k on the mortgage at this point in time. His mortgage broker calls and offers a deal – for a $4,000 breakage fee he can get a new mortgage for 4%.

Joe does the math (without prepaying) and concludes that he would break even so it is not worthwhile. Then he gets a call from Mr. Cheap explaining how to lower the termination costs by borrowing some short term money. Joe can prepay $30k so he can lower the termination fee by $1200 to $2800. Even if he pays $100 in loan interest then his profit is still $1100.

Needless to say Joe is pretty excited and goes ahead with the deal.

However that night Joe gets another phone call from someone named Mike who points out that he left out an important number from his original calculation. Joe (and Mike) didn’t add the termination fee to the amount of the new mortgage. Adding $2800 to the mortgage will increase his interest costs by $336 (for 3 years) which lowers his profit to $760. Not bad, but it’s debatable whether it is worthwhile or not.

Blend and extend

“Blend and extend” sounds like a good recipe for a fancy drink. It’s hard not to be positive about a smooth sounding marketing line especially when there are no termination fees to worry about. But is it too good to be true?
A commenter on my blog gave some details about his ‘blend and extend’

In our case we were 2 years into a 5 year fixed at 5.09%. By blending and extending we brought our rate down to 4.81% (for 5 yrs)
…
and it cost us a mere $75 to take that option and the paperwork was 1 page or 2. No legal fees or termination fees required in blending and extending.

As I interpret this – the ‘penalty’ is that he just got a 5 yr mortgage with a well-above market rate interest rate. Right now you can get a 5 yr mortgage for just under 4% so the extra ~0.8% is the penalty. This is not to say that ‘blend and extend’ is a bad deal, but rather that it’s probably not any better than a normal refinance where you pay the penalty and get a lower rate.

Switch to variable?

Another strategy is to pay the termination fee on your long-term mortage and then go for a variable rate or 1-year deal. The rates are so low that this is very tempting. However, if you do this you are really just making a play on interest rates. If you guess right then you might save a lot of dough, if you are wrong then you might be better just leaving things well enough alone.

What’s your story? Have you refinanced lately? Share ALL the details and why you think you are saving money.

It hasn’t even been six months since Ben, an astute observer of financial matters, noted that the spread between a 5-year fixed rate mortgage (FRM) and a variable-rate mortgage (VRM) was unusually low and it may be better to buck the conventional wisdom and opt for a fixed-rate mortgage. Not anymore. Fixed-rates have been relatively steady — according to Invis, a mortgage broker, the “best” 5-year rate available currently is 4.09%, just a smidgen higher than the rate reported earlier. But with the credit crisis easing, VRMs have become much cheaper. While the best rate available on a VRM just six months back was Prime plus 0.80%, today Invis is offering VRMs at Prime plus 0.10%.

Canadian Mortgage Trends reported just the other day that BMO has lowered its variable rate to prime and other banks may follow suit. With a spread of 1.75% between a FRM and VRM and the Bank of Canada saying it intends to keep rates level until 2Q-2010, VRMs may once again be poised to deliver savings over FRMs. The usual caveats apply: mortgagees opting for VRM take on the risk of a spike in interest rates in return for the potential to save interest on their mortgage.