Switch After 12 Months?

mortgage-switch One year ago, people were paying prime rate for new variable-rate mortgages. (See: First to Prime)

Today, the market is down to prime – 0.70%, or thereabouts.

For those who got their mortgage 12 months ago, many wouldn’t even consider refinancing as an option. But, an option it is.

Let’s illustrate.

First, we’ll assume our hypothetical borrower has:

  • A 5-year variable-rate term
  • A $250,000 mortgage amount
  • A 25-year remaining amortization

Now, suppose:

  • Our homeowner’s mortgage is at prime rate (2.75%) today
  • She swaps for a new variable-rate mortgage at prime – 0.70% (2.05%)
  • Prime rate increases 25 bps on Sept. 8
  • Rates then stay put until June 2011 (Not our prediction; just an assumption to match the “pause” forecast by most economists.)

Here are the results:

  • Interest savings:  $8,345 (hypothetical over 60 months)
  • Penalty:  $1,719 (three-months of interest)
  • Discharge Fee:  $250 (depends on lender and province)
  • Net benefit of breaking early:  $6,376 (roughly)

For most people, saving thousands over 3-5 years isn’t exactly the worst idea. So, if you’re currently in a variable at prime rate or above, find a mortgage planner to see if it makes sense to switch.

It doesn’t have to be a variable rate you switch into either.  There are arguably even better deals on 1- and 3-year fixed terms.

  1. I fit the prime variable scenario outlined in this post. When we were mortgage shopping a year ago, prime was the best rate going.
    Excuse my ignorance, but how is it that mortgage lenders can offer such large reductions from prime, while rates have been climbing? Can we expect them to be reduced further: minus .9 or 1.0 ?? How long should we expect minus .7 to be available?

  2. I currently have a prime -0.9 variable which I obtained in ’07 so I know it can happen. However, I don’t know what needs to happen in order for further reductions from prime to become available.

  3. I also have friends with very good discounts from around that time. Can someone explain what the mechanism is that controls how lenders deviate +/- from the prime rate? What can we expect going forward? I for one, would love to switch out of my prime variable for prime – 0.7, but given the penalties, should I wait for – 0.9 before switching?

  4. thats all well and good but when will the Industry get rid of the criminal IRD penalties that are preventing 1,000s of us from re-financing and sitting on 6% or thereabouts fixed rate mortgages. Its absurd.

  5. How is being held to a fixed closed contract that a person knowingly signed absurd? To suggest IRD penalties are criminal is to suggest they are illegal?
    Financial markets would cease to exist if people were allowed to willingly break fixed contracts without recourse so if you don’t want to pay IRD penalties, then stop whining, opt for an open mortgage and pay the premium for such flexibility.
    But to answer your question, I expect they will never get rid of IRD penalties but I do think the market needs better IRD penalty calculation disclosure legislation.

  6. TD will give you back your 3 month interest penalty when you refinance you closed mortgage into another closed mortgage. Did you know that? You do however have to drawdown $20k, pay any small fees ie legal, appraisal, etc, but still not a bad deal! You will save thousands.

  7. Excuse me for being picky on the numbers, but shouldn’t the results be based on 48 months of interest savings, if switching 12 months into a 5 year variable? The numbers still justify the switch after one year of course, with $4707 of savings…

  8. Hi Tom,
    That’s an excellent question. Since the borrower would be committing to a new five-year term now, we compare that entire five year term to his current remaining term (48 months), plus his estimated rate at renewal in year five.
    This simulation assumed renewal into a mortgage at prime rate in year five (akin to a HELOC rate for example). If you assume the borrower renews into a prime – 0.70% variable in year five then the savings is $6816 over five years (instead of $8345)–less refi costs.

  9. Be very careful of this as I have worked for the Banks and know that they hardly ever pay mortgage penalties. They will blend your rate which means your paying the penalty over time. If todays rate is 3.75% on a 5 year fixed and your rate is 5.75% they are not going to let you out of that term and into 3.75% without either capitalizing some/all of the penalty or giving you a blended interest rate calculation for the rest of your existing term. Maybe they will give you the 3 months interest back but they certainly wont give you back the IRD penalty they will charge which in a lot of cases is huge! Proceed with caution on any deals you see like this.

  10. My branch knew nothing about this. Aparently they called to verify what you are saying Jessie and “TD’s lending centre” said it is not possible. I guess I’m stuck paying a penalty to refinance my mortgage. :(

  11. Hi Rob,
    I also signed up for a 5 year variable at prime back in Nov 2009. I’m a little over 1 year in and weighing my options at this point. I’m don’t mind a “no frills” option- it’s a rental property so I’m not too interested in prepaying as I can write off the interest, and I don’t plan to sell. I have $435000 left on the mortgage.
    I spoke to my bank and the 3 months interest penalty is $2700 and fees of approx $200. Their 5 year variable rate is 2.3% with an option to fix into their discounted fixed rate later on. Do you foresee further discounts on prime going forward? Would a 1 year fixed rate or 3 year variable rate be a better option? Are there better variable rates out there?
    Thanks in advance!

  12. You should really get a mortgage broker and ask them all these questions; they’ll find the best product and rates out there for your situation if you want to switch. You’ll most likely get something better than what your bank will offer.

  13. Hi Lorca,
    Nicole is right. Most mortgage brokers will find a better rate than prime – 0.70% for a well-qualified borrower, possibly with better features/terms as well.
    A good mortgage planner will also:
    * Compare all closing costs to see if it makes more sense to remain with your present lender
    * Compare each term both mathematically and based on your risk profile. That will indicate whether another term might make more sense than a 5-year variable.
    Here’s a list of planners if you’d like to find one in your area, or feel free to email us if we can be of further help.

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