Mortgage

Refinancing Your Home

October 13, 2009

14 comments

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.

Time to opt for a variable-rate mortgage again?

September 27, 2009

17 comments

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.

Bucking the conventional wisdom on a fixed-rate mortgage

April 5, 2009

63 comments

It is now widely-known that homeowners can save money by opting for a variable-rate mortgage over a fixed-rate mortgage in the vast majority of instances. Ben, an astute observer of financial matters, recently grappled with the question with his own mortgage and decided that with potential high inflation in the future and low spreads between fixed-rate and variable-rate, this might be one of those rare occasions when it makes sense to go fixed. According to Invis, a mortgage broker, fixed-rate mortgages can currently be had for 3.99% over 5 years compared to variable at 3.30% (Prime + 0.80%).

Should you go with a fixed-rate mortgage (FRM) or a variable-rate mortgage (VRM)? One thing is clear about questions of this nature: nothing is ever clear. In the same way that RRSP vs. mortgage vs. TFSA can never be answered definitively for all cases, the decision on whether to take a variable or fixed mortgage interest rate can also never be resolved in cookie-cutter fashion.

To paint broad strokes, banks charge a premium on FRM’s to accept the risk that money will not be so cheap in years to come – by accepting a VRM, and hence the risk, you stand to save money, historically, and on average.

Widely-reported Dr. Moshe Milevsky of York University authored a study in 2001, with a subsequent update summarized nicely here, where 90.1% of the time over 1950-2007 it was better to have chosen a VRM over a FRM (down to 77.1% if you have good negotiation skills and credit, and can secure a discounted rate). As discussed in the comments there, it would be nice to know what conditions existed in those minority of times when it was better to have a FRM, ie. historically, given that prime rate was x%, what was the probability that fixed would fare better than variable over the next finite time period?

Given that mortgage interest rates are currently at an all time low, one has to wonder whether historical studies have the same relevance when brought to bear on current market conditions. The spread between VRM and FRM is extremely slender at the moment – on a standard 5-year term closed mortgage, the best discounted VRM today is just north of 3% and the best discounted FRM is about 4%. The narrower this gap, the better one’s probability of doing better with a FRM.

Some have argued that when rates do begin to go up, as they almost certainly will in time, the increases will be modest at first and at that point early in the rise one can lock in to a fixed rate. However, it is a certainty that by the time the average Joe realizes it’s time to lock into a fixed rate, the banks will have raised the fixed rate higher than he could have gotten today. This becomes a case of pay less today on your VRM, pay more tomorrow on your FRM.

In a recent discussion, Dr. Milevsky states generally that people with a lot of assets and therefore increased ability to deal with risk should still consider a VRM. Dr. Milevsky offers that those with small home equity, or low or unstable income, may want to consider a FRM.

Historical studies aside, there are some elephants in the room these days. Job stability is at generational lows, house prices are in steady decline, the future of North American automakers hangs in the balance, and governments are pumping trillions into the financial system with uncertain results. These are uncharted waters.

Ultimately with mortgage rate choices, as with all other aspects of personal finance, it comes down to risk management. If we pull out all the stops in efforts to maximize the slice of pie at retirement, we run the risk of burning the pie, or finding we’ve arrived at the dinner table without a plate and fork. If we don’t take the occasional calculated risk, however, we may find that there’s not enough pie to eat on Tuesdays.

And as always, more important than the decision you make on VRM vs. FRM is the decision you make in your day-to-day life to control your expenses, increase your income, and direct the net savings toward paying off the mortgage and maximizing registered and non-registered investments.

[Update: You may want to check out this post on Canadian Mortgage Trends on the same topic.]