Six in 10 mortgage consumers choose brokers, in large part because they think brokers will get them the best rate.
All too many of those people associate the “best” rate with the “lowest” rate. Mortgage professionals know that’s not generally true, but convincing clients of this isn’t always easy.
While rock-bottom “no-frills” mortgage rates may look great in an advertisement—and can indeed save you a significant amount of interest if you don’t renegotiate early—it’s the loss of flexibility after closing that really stings people.
For thoughts on how mortgage shoppers can better choose the real best rate, we reached out to two seasoned mortgage pros who know rates as well as anyone. Both run mortgage rate comparison websites—James Laird, co-founder of Ratehub.ca and Rob McLister, founder of RateSpy.com—but are the first to admit that the lowest rates are usually not the best rates.
What makes a great rate?
“The ‘best’ mortgage rate means the lowest rate available for a mortgage that contains all of the features and terms the client is looking for,” says Laird.
He notes that some of the key features rate shoppers should consider include the penalty to break your mortgage; pre-payment privileges (i.e., the lump sum payments and percentage increase to your monthly payments that are permitted each year); whether it comes with a Home Equity Line of Credit (HELOC); and the rate hold period.
Laird adds that quality of service from the lender should also be on consumers’ radar when rate shopping.
“Does the lender have a reputation for offering good service? Even if a mortgage has a feature that a customer wants, they will often need to work with someone from the lender to execute said feature,” he said, such as porting a mortgage from one property to another or doing a “blend and extend.”
For McLister, the “best” mortgage rate is one with “the highest probability of maximizing your net worth. That means choosing the optimal combination of interest rate savings, term length, rate type, origination fees, post-closing fees, advice and flexibility,” he said.
As for the key features rate shoppers should take into consideration, McLister adds, “Depending on one’s circumstances, a borrower might need to overweight factors like payment flexibility, refinance options, porting rules, prepayment allowances, readvanceability, prepayment charges and so on.”
How a lower rate could end up costing you more
We all know that the cheapest rate doesn’t necessarily translate to the lowest borrowing cost. Lenders are able offer reduced rates because they typically strip out flexibility.
“A less-frills mortgage that makes you pay a higher rate or bigger penalty could easily cost you 3–4 times the interest rate savings,” said McLister. “For example, if you move and your closing date is 60 days away, but your lender only allows 30-day ports, you could be stuck paying thousands in prepayment fees and/or lose your pre-existing low rate. Or if you need to refinance but your lender doesn’t let you refinance elsewhere before maturity, you could easily pay 1/2 point more than best market rates.”
Laird notes that the difference between “no frills” rates and full featured rates is usually around 10–20 bps. He provided this example to illustrate how you would be further ahead by choosing a full-featured rate in the event you break your mortgage:
Mortgage size: $400,000
Amortization: 25 Years
Term: 5-year variable
Difference between no frills and full feature rate: 20 bps (3.20 % vs. 3.00%)
Client breaks the mortgage after 2 years
Penalty to break low-frills mortgage: 2.75% of mortgage balance
Penalty to break full feature mortgage: 3 months’ interest
“While the “no frills” rate will have saved you $1,555 of interest, the penalty to break would be $7,362 higher,” Laird explains. “So the net cost of the no-frills mortgage would be $5,807.”
How can shoppers decide what’s best for them?
No one can predict their future housing and financial needs with 100% certainty. But mortgage shoppers should still take the time to contemplate their long-terms goals and expectations. That’s the only way to make an educated guess as to what their mortgage needs will be.
“Some of the more common questions,” McLister says, are, “‘What are the odds I’ll move before my mortgage matures?’, ‘Where will I move and how much might I spend on the new home?’, ‘Will I need to tap my equity at some point?’, ‘Will I still qualify if I need to renegotiate my mortgage?’ and ‘Am I better off with a longer amortization?’”
Additional questions suggested by Laird are:
Do you expect your earnings to change significantly during the term of the mortgage?
Will you receive significant bonuses during the term of the mortgage?
Will you need to move cities during the term of the mortgage?
Do you view the current property as a “starter house” that you will upgrade when you have the financial means?
What is your relationship status? Is there a chance you will enter (or exit) a relationship during the term?
Will your family grow during the term?
Will any family members move out (or back in) during the term?
Do you plan on doing any renovations during the term?
Will you require any significant amounts of cash for other parts of your life during the term?
Questions like those above can quickly weed out mortgages with restrictive charge terms. If necessary, brokers can take a client’s scenario, make some basic assumptions and show how a low-frill mortgage’s penalty, refinance or porting restrictions can cost them more than a tenth of a per cent rate discount.
Rate Comparison Sites as a Tool
With the advent of mortgage rate comparison sites, rate shoppers now have more information than ever at their fingertips. But McLister cautions that rate sites such as his are only a starting point when researching a mortgage.
“Rate sites reduce information asymmetry between consumers and lenders/brokers, but they’re not a miracle tool—not yet anyway. They don’t, for example, list all the qualification criteria or nuances of each product. That’s where an honest, experienced broker comes in,” McLister said. “If you want a quality personalized assessment of your options, you generally have to pay for it. You can’t expect a mortgage expert to perform in-depth analysis of your optimal financing options and give you rate site rates.”
He adds that every borrower needs to truthfully assess his or her own mortgage knowledge and then decide what level of advice and service they’re willing to pay for.
“A salaried online-savvy 49-year-old renewing for the fourth time and 25-year-old self-employed first-time buyer might both be suited to a 5-year fixed, for example, but their qualifications and need for flexibility and guidance, and hence their ‘best rate’ might be very different,” he said.
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