While big banks are advertising 4.25% for a 5-year fixed, you’ll find brokers now quoting under 4.00%—with many as low as 3.85% or less.
Be aware, however. The really low rates you see on some broker sites (3.85% and below) are generally not your typical mortgage. They’re usually “no frills” products.
That means you get:
- Minimal pre-payment privileges–typically 0-5% (vs. 15%-25% elsewhere)
- Minimal payment top-up options—usually 0-5% maximum per year (vs. 20-25%)
- 30 day closing deadlines (vs. 90 to 120-days)
- Restrictions on how many pre-payments you can make in a year (vs. the ability to make extra payments on any payment date)
- No pre-approvals
- Restrictions on which lender you can transfer from and still qualify for free legal fees
- Lack of availability in all provinces
- Potential lack of portability
- Longer-than-normal turnaround times on approvals
- Subpar service after closing
No Frills mortgages are bare bones products designed for one type of person: someone who doesn’t want to pay for added flexibility.
No Frills products are also sometimes used as bait. It’s no secret that low rates generate phone calls. Once a customer is on the hook, he/she can then be upsold into a more profitable mortgage. (That is how a small number of people–but by no means the majority–use them.) Over time, our prediction is that you’ll see more and more mortgage sites advertising no frills rates for this reason.
In terms of pricing, no frills mortgages are usually 0.10% to 0.20% cheaper than fully-featured mortgages. On a $200,000 25-year mortgage that will save you about $1430 over five years.
So the big question is: should you get one?
If you’re closing in 30 days, want a 5-year fixed mortgage, and don’t plan on paying down your mortgage aggressively, a no-frills product might be suitable. Mortgages are not unlike a car purchase. It’s kind of a waste to pay more for a Porsche if you’re never going to drive it fast.
On the other hand, pre-payment privileges can come in handy if you expect to have free cash flow. Pre-payments provide one of the best risk-free after-tax returns you can get.
Using our prior assumptions, if you make a 13% pre-payment on a fully-featured mortgage (13% x $200,000 = $26,000) at the end of year one, the interest savings of the no frills mortgage disappears. Any lump-sum pre-payments above 13% would then make the fully-featured mortgage the clear winner—despite its 0.15% higher rate.*
Pre-payments also come into play if you pay out your mortgage early. (Most 5-year fixed mortgages are paid out 1-2 years before maturity on average) Making a pre-payment right before your discharge can reduce your penalty by 20% or more. This is especially relevant if IRD penalties apply.
* We’re comparing to a no frills mortgage where the hypothetical homeowner is making a 5% prepayment under the same timeframe (i.e. one year into the mortgage).
Note to reader: In the event the satire of the above image fails, let us confirm that the No Frills grocery chain has not followed Loblaws into the mortgage business. "No frills" is merely mortgage industry jargon and there is no affiliation with this most frugal and fantastic grocery store franchise.