Restricted Mortgages. The Rate Sells.

One basis point (“bps”) equals one one-hundredth of a percentage point (0.01%). On a $300,000 mortgage, a rate that is one bps higher boosts the payment by a scant $1.49 a month. From the way some folks select a mortgage, however, it might as well be $149 a month.

Many consumers simply have the blinders on to anything other than the interest rate. That’s leading more and more lenders and brokers to undercut each other by as little as one bps. This is often all it takes to get their phones to ring.

According to this author’s mortgage comparison website data, the lowest rate for a given term garners about 39% of visitor clicks. Meanwhile, the second-lowest rate attracts only 15% of clicks.1 That’s despite the second best rate being only 1-2 bps higher on average. It is this type of rate sensitivity that’s driving the growth of restricted mortgage products.

Restricted mortgages are those that cut prepayment privileges and/or make it expensive or more difficult to discharge the mortgage before maturity. Those limitations reduce a lender’s costs, making it possible to shave precious basis points off the interest rate. A growing number of lenders are now selling such mortgages, including BMO, Merix, MCAP, RMG, Industrial Alliance and Canadiana Financial, among others.

“These products are really for a high-ratio client who’s going to stick with it for 5 years,” says Suzanna Stefanec, VP, National Sales & Products at Radius Financial. “You can’t refinance over 80% loan-to-value anyway.”

“You’re seeing all these lenders coming out with restricted mortgages so there’s obviously demand,” she adds. “These low-frills products are almost the wave of the future.”

Stefanec’s company launched its own lower-frills variable-rate mortgage this spring (details below). “Our fixed RateWise has been a success for us. So with consumer demand for variables coming back, it was a no brainer to create a version for ARMs (adjustable rate mortgages).”

But not everyone’s cut out for a restricted product. “The wrong person for this mortgage is a young couple with ample disposable income who’s just starting out and thinking of a family,” says Stefanec. “They may get a starter home knowing that in a few years they’ll likely have kids and need a larger house…If they have that income, they’ll want to make that move,” in which case, choosing a restricted mortgage that charges a penalty to increase the loan amount isn’t so smart.

“It’s also not for someone who can prepay more than 10% of their mortgage, or who may need to pull equity out of their home for renovations, a cottage purchase, etc…Those people will want additional flexibility and be willing to pay for it.”

Keep in mind, less than 1 in 5 Canadians even made a lump-sum prepayment on their mortgage last year, according to CAAMP data. For that reason, 10% annual prepayments are more than enough for most homeowners. It’s the refinance limitations that you’ll really want to weigh carefully.

The RateWise ARM:

Here’s a quick look at Radius Financial’s recently launched RateWise ARM…

Current Rate: Prime – 0.70% (if high ratio; add 5 bps if conventional)
Rate Hold: 90 days
Maximum Loan: $2 million (There’s no sliding scale but loans over $1.2 million must be insured)
Prepayment Options: 10% lump-sum (on the anniversary date) and 10% payment increase annually
Penalty: 3 months’ interest
Early Payout: Only allowed with a bona fide sale
Port Gap: 30 days
Blend & Increase: No. A penalty applies if increasing the mortgage amount before maturity
Other: The property must be owner-occupied. Switches are OK. This mortgage can be converted anytime to a 5-year fixed RateWise mortgage

The three-month interest penalty is a key benefit of the RateWise ARM, relative to some competitors’ restricted products. Some competing products entail penalties as high as 2.75% to 3.00% of the mortgage balance.

1 Source: “Lowest rates” refers to the lowest rates for a given term (be it a 5-year fixed, 5-year variable, or whatever), relative to other rates for that term.

  1. People are getting these low frills mortgages to save maybe 10 basis points but paying a 3% penalty in some cases. On a $200,000 variable mortgage that is a $6000 penalty instead of the usual $1000, all to pay $900 less interest? I don’t get that math.

  2. The rate difference is more like 15 basis points in some cases and if the differences between the two products are thoroughly and properly disclosed why can we not allow the consumer to decide for themselves. The consumer is the in the best position to decide whether they will be in the property for the next 5 years. Finally, if the mortgage broker convinces the client they should take the higher rate to be “safe” is the mortgage broker willing to rebate the difference between the two rates at the end of 5 years if the client never sold the house and did not refinance?

    1. I’m of the opinion that a mortgage broker should not be “convincing” the client of anything in particular, other than the assurance that the broker is offering the best advice possible; thereby allowing the client to make a logical decision in relation to their specific needs and circumstances.

  3. Brokers are paid to advise borrowers to the best of their ability. They won’t always be right but they should always be honest.
    So many people refinance early who never expected to. I think it’s a broker’s job to factor that into their recommendation.
    Penalizing an honest advisor for trying to protect their client is a slippery slope. Are you also going to make financial advisors rebate lost gains if they recommend fixed income investments for safety but stocks have higher returns? Of course not.

    1. How can you ‘factor in’ some future event you don’t know will happen?

      That’s about as sensible as trying to predict the direction and level of interest rates.

      1. Great question John. Financial decisions, whether they be investment, insurance or mortgage-related, are always made in a cloud of uncertainty. We can’t predict future life events with precision but one can rationally guesstimate probabilities for them. Doing so won’t be foolproof (it’s not meant to be). With mortgages, the intention is only to illustrate how different outcomes might impact your borrowing costs with different lenders, terms and products.

        For example, if you get a variable-rate mortgage with a high 3% penalty, and you feel there’s a 50% chance you’ll break that mortgage, the expected cost of that penalty is 1.5%. That cost is added to the other costs of borrowing (projected interest, fees, etc.), enabling clients to compare the total hypothetical cost of various products. (Forgive the oversimplification as there’s more to it that this.)

        Few mortgage advisors explicitly weight probabilities to estimate borrowing cost in this manner, but it is possible and it does yield better recommendations.

  4. There are two fair comments here, my position is just ask the client what their opinion whether or not they will need to break the mortgage in the next 5 years and let the client decide. Appraiser is right, we as advisors should avoid trying to “convince” the client of anything.

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