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29 Sep

Should I refinance for a lower rate?


Posted by: Darick Battaglia

Should I refinance for a lower rate?
Does it make sense to break my current mortgage and lock it in at a lower rate?
If you are looking to free up cash due to layoffs associated with COVID-19 and may need to refinance their mortgage, others might just decide to sell their home or simply looking to take advantage of the lower rate for a new 5 year term.
Regardless of the reason you might have to break your current mortgage, you will likely have to pay a penalty.
A pre-payment penalty protects your lender who was counting on interest payments from you for a specified period. When you pay your mortgage off quickly, no matter how you do it, your lender is getting less than they anticipated in interest payments and you have to pay a price for changing or opting out of the contract.
If you have a variable rate mortgage, you will have to pay a three-month interest penalty. However, if you have a fixed rate mortgage you will have to calculate three months of interest and the interest rate differential (the rate you have compared to the rate you will get) and pay the greater of the two options.
Before you break your mortgage, here’s what to remember:
• Know there will be a penalty.
• Have your financial institution break down the numbers for you.
• Understand there will be fees and that every bank is a little different.
• The penalty you pay has to be less than the gain you will achieve or it simply isn’t worth it.
Knowing your numbers makes this an easy decision.
But not all lenders calculate their Interest rate differential penalty the same.
For example with CIBC the IRD penalty for a $350,000 obtained 3 years ago at a rate of 3.39% is approximately $14,260
And with one of Canada’s leading monoline lenders such as First National using the same numbers above the IRD penalty is only $7975.
This penalty Is bulked into the new mortgage being obtained at the new low rate of say 2% and not paid out of pocket upfront
How can you be sure if you are saving money even after paying the penalty?
We can calculate the savings by using the new payment difference over the remaining term and new remaining balance of the mortgage after the same time.
2 years remaining in term
Balance at end of 3 years $321,807
Payment $1,727.19
Refinance at new 2% rate – 5 year term
$321,807 plus penalty – balance after 3 years into the term plus penalty $7975 = $329,782
Payment $1396
Savings monthly payments : $1727 – $1396 x 24 months = $7944
Plus you get the added advantage of having a guaranteed locked in rate of 2% for another 3 years.
Because the new mortgage rate is so low this would also be an ideal time to add in additional debt you may be carrying such as credit cards and loan, add extra money for renovation to sell or improve you living environment, monies for investment or education.