In our April 2016 issue of MoneySense, we introduced you to Sammu and Mandy Dhaliwall, a young married couple with three kids from Brampton, Ont. They are trying to juggle RRSPs, TFSAs, paying down their $350,000 mortgage as well as their $90,000 home equity line of credit. Throughout the year we’ll be giving them a financial challenge every four weeks to help them get their finances in tip top shape. Make sure to follow along! Let’s start.
Challenge No. 1
The Dhaliwalls’ first challenge was to go shopping for mortgage rates and find out what new rate and terms they’d be eligible for this July when their mortgage comes up for renewal. Most institutions offer a three-month interest rate guarantee. The couple was asked to check out RateSpy.com, a website that keeps track of mortgage rates offered by financial institutions, and then use this information as a bargaining chip with their own mortgage provider to potentially get a lower rate. The couple also inquired to see if they could roll their line of credit (LOC) into their mortgage to see if they could save some money doing this, as LOCs are usually 1% (or more) higher than variable rate mortgage rates.
Sammu and Mandy’s experience
For our first challenge, we made appointments with three mortgage providers: our current mortgage provider, a big bank, and a mortgage provider from RateSpy.com.
Based on current markets, we felt a fixed-rate mortgage for a four or five-year term is what would suit us best and made comparisons based on this. (It’s interesting to note that all three mortgage providers we contacted also recommended a fixed rate over a variable rate).
The big bank we contacted was offering either a 2.49% for a four-year fixed rate mortgage or 2.59% for five years. The mortgage provider from RateSpy.com was offering 2.54% for five years with the rate guaranteed for 90 days (a lower 2.44% rate was available for five years but guaranteed for only 60 days). Our current mortgage provider is offering the same rate as the big bank.
When we asked our current mortgage provider to match the lower rate, we were told that it was possible to get a lower rate once the application is put through. This is where we were not sure what to do. Both of us believe that to get a guaranteed rate for every mortgage application we make, our credit score would be affected negatively—so we didn’t want to fill out multiple applications to get guaranteed rates we may not use. Nonetheless, on a 25-year amortization, we would save just under $21,000 on interest with the lower 2.59% rate.
We also looked at refinancing our mortgage with debt consolidation. We were provided an option of either rolling the debt into a higher mortgage or paying off the debt with home equity. The latter option would lower our rate from the current prime + 0.5% to just prime for annual interest savings of about $400. The first option would actually reduce our monthly payments; however, over the amortization period of 25 years, the total interest paid would increase by over $20,000 when compared to only about $14,000 in total interest if we continue to pay down our line of credit at the prime rate.
So, although our monthly payments would decrease by consolidating our debt into a refinanced mortgage (by about $700/month), our total interest paid over the amortization period would increase quite a bit (by about $14,000) when compared to using a home equity line of credit (HELOC). So, currently, we are leaning to keeping our mortgage amount as is but starting a HELOC to pay off the debt at a lower prime rate. Is this correct?
What the experts say
“The fact that your bank can only get to within 0.05% of RateSpy.com is unfortunate,” says financial planner Jason Heath. “But keep in mind that’s only $50 per year on $100,000 of mortgage principal.” Heath explains that the amortization doesn’t matter for purposes of calculating the ‘cost’ of the higher interest rate—the rate only applies for the couple’s five-year mortgage term, not their 25-year amortization. “In five years, they’d be renewing their mortgage at a new, different rate,” says Heath.
Heath also reminds Sammu and Mandy that, when looking at mortgage options, they also need to consider other factors like the ability to make pre-payments, increase payments, port the mortgage to a new home, as well as any potential appraisal, registration or other fees. “You might save a couple hundred bucks in interest just to pay a couple thousand in other costs,” says Heath.
Regarding the couple’s concern about multiple mortgage applications, according to credit agency TransUnion: “The only inquiries that would affect your credit score are those initiated by you for specific credit transactions. Also, most scoring models take the appropriate steps to ensure that your score is not lowered because of the multiple inquiries that might occur in a specific time as a result of shopping for the best terms for an auto or home loan. Inquiries have less importance than delinquencies, balances owed and the length of time you have used credit. In general, scores only consider inquiries from the last 12 months. Inquiries are usually more important in affecting your credit score if you have a limited credit history.” Translation? Multiple inquiries within a short period of time are treated as one single inquiry, so the Dhaliwalls shouldn’t be too hung up on this.
To get an accurate bottom number for the Dhaliwalls, MoneySense asked Robert McLister, a mortgage expert and founder of RateSpy.com, to run the numbers for the couple. McLister factored in that full-featured five-year fixed mortgages for July closings are currently available in the 2.49% range. “The incumbent lender will typically price higher than the best market rates, unless they feel the customer is likely to leave, in which case they’ll usually negotiate.” says McLister.
McLister stresses that without question, rolling the line of credit into the mortgage would save the couple money. He also notes that moving a $90,000 debt from a credit line at prime + 0.50% (3.20%) to a fixed mortgage at 2.49%, saves $3,011 of interest over five years. “That’s based on a 25-year amortization which, compared to the infinite amortization of interest-only payments, ensures the debt is actually paid down,” says McLister. “On a side note, no one should rack up higher-rate credit line debt and expect to pay it back over 25 years, unless perhaps it’s for investment purposes.”
The total annual payments, with an accelerated bi-weekly frequency, would be $25,595. With regular (non-accelerated) bi-weekly payments, the total would be $23,613. That’s based on a 2.49% five-year fixed rate amortized over 25 years. McAllister explains how the Dhaliwall scenario works.
“If we’re comparing one $440,000 mortgage at 2.49% to a $350,000 mortgage at 2.59% plus a $90,000 credit line at prime (2.70%), the five-year interest savings of the former is $2,634. That assumes a 25-year amortization and equal monthly payments in both scenarios. When comparing two mortgage scenarios it’s important to assume the borrower is willing to make the same monthly (or bi-weekly) payments in each case. Otherwise we run into questions about what he/she is going to do with the payment savings of the cheaper rate.”
On a final note, McLister adds that the savings from consolidating into one mortgage would be even greater if the prime rate rose, or if the borrower decided to keep making interest-only payments on the credit line.
Want to start your own money makeover? It’s easier than you think! Join the Money Fit Club to curb spending, boost your earnings, lower your taxes and more!