I have a $270,000 mortgage. The penalty to refinance and take advantage of a lower interest rate is in the range of $6,500. Is it to my advantage to pay the penalty? If so, should I go with a 2.99% four-year term or a 3.99% seven-year term?
Inertia is a powerful force. It works very well when you are on a beach vacation or when you set up an automatic withdrawal into your RRSP to save for your retirement without having to lift a finger. But it doesn’t work so well at times like this when mortgage rates are so low. I talk with a lot of people who are so overcome by inertia that they keep paying their mortgage without ever doing the math to see if refinancing makes sense. But you are not doing that. You are asking the question, and good for you.
Some of the information one needs to answer your question is above, but not all of it. You need to pull out your current mortgage rate as well as the amount of time left in the current term to do the calculation properly. With that info in hand, I would take the following steps:
- Consider using a mortgage broker: The market for mortgages is incredibly competitive these days. A great mortgage broker keeps on top of current rates at the big banks as well non-bank lenders that you may not have heard of. The mortgage broker then earns his or her commission by finding you the best deal out there. Your bank can do these refinancing calculations of course, but a broker will be able to bring more options to the table.
- Review the calculations: A mortgage broker will show you what your interest savings would be if you were to refinance and whether the savings are enough to offset the penalty. Joe Jacobs, a mortgage broker with Mortgage Connections Inc. in Calgary, says that no one can guarantee where rates will be when your term is up, but it is a relevant point to consider. “Securing a low rate now, even if the savings are not significant after the penalty cost is calculated, can be a smart hedging strategy against potential higher rates come renewal,” he says.
- Consider other borrowing needs: While you’re in the meeting, ask any other questions you have about borrowing. I do not mean using your refinancing as a way to fund the trekking trip to Nepal, or installing a 12-person hot tub on the roof of your garage, but it might be worth consolidating your credit card debt if you have any outstanding. Click here for a post on some of the pros and cons of debt consolidation.
- Reduce your amortization, not your payment: If it does make sense for you to refinance, be sure to make good use of the savings. Everyone’s circumstances are different, of course, but in many cases it makes sense for you to hold your monthly payment at the same level as before. By keeping your payments stable you will reduce the amortization period, which means that instead of becoming mortgage free in 15 years, you could pay off your home in, say, 11 years. Alternatively, you could use the room created by a lower payment to increase contributions to RESPs or RRSPs. My point is, don’t squander the opportunity to get ahead by spending the savings on things you don’t really, really need. (Hot tub = want not need.)
- Choose your term: The broker can also provide insight on the second part of your question—whether you should choose a four-year or seven-year term. Jacobs says it is a hard choice to make and it depends on whether the goal is to have the greatest savings up front or long-term rate security. “The 2.99% is giving you more upfront savings, but you take a chance on what pricing may look like four years down the road. A longer term would cost you more on the front end, but potentially save you money later on. This is a gamble and we will not know the right call until four years out,” he explains. He goes to say that he does not like the seven-year option presented, when fully flexible 10-year money is available at 3.89%. “Either a four year at 2.99%, or 10 year at 3.89% would work.”
Now is the time to do your due diligence and make an informed choice. Lowering your mortgage costs and doing something smart with your savings could be great way to help you get a handle on your money so you can live the life you want.