If you are like most, the first question that you’ll ask a mortgage professional is “what is your best mortgage rate.” While rate is a highly important component, there several other important factors that need to be considered when shopping for a mortgage. Contrary to popular belief, rate is not the most important one.
There are four elements to consider, and in this order of importance:
- The person you choose to handle your mortgage for you
- Terms and conditions
- Mortgage rate
- Lender
Let’s take a look at each one of these elements individually so you have a better idea of why I’ve put them in that order.
1. The Person You Choose To Handle Your Mortgage
A mortgage is a huge financial decision. Perhaps the largest financial decision you will make in your lifetime. You have tens of thousands of dollars at risk when you put down your deposit to purchase a new home. Just because your professional of choice hands you a mortgage commitment outlining all the terms of your approval, this does not mean that you are 100% approved. In fact, nothing is ever 100% in this industry. The only way to be 100% certain that your home purchase is going to close is if you have 100% of the money to pay for it outright. When lender issues a mortgage commitment, it’s not a legally binding document. You can cancel with that lender at any time, and you don’t even have to give them a reason why.
This works both ways however.
The lender can also cancel your commitment (approval) at any time, right up until closing date. They also do not have to give you a reason why. It doesn’t matter if you are dealing through a major bank, credit union, or monoline lender, the same rules apply.
There are literally thousands of things that can go wrong with your mortgage prior to closing. The appraisal could come in low, the lender could do a final review of your documents and find something that was previously overlooked. They could suspect that something was misrepresented. In some cases, it could come to their attention there is a problem with the property itself.
Lenders backing out of commitments at the last minute are rare, however you can minimize the risk by choosing the right person to work with. Regardless of whether you are dealing with a bank or a broker, the role of mortgage professional has a low barrier of entry. For that reason,
you’ll get your fair share of incompetent individuals calling themselves mortgage ‘specialists’ advising you on what you should be doing with your mortgage. There are many who are money driven rather than client driven, who will push you into products based solely on their own compensation, rather than those better suited to you as a client. This applies equally to banks and brokers.
By choosing the wrong person to handle your mortgage for you, you could be putting your deposit at risk. Not to mention your emotional sanity! It doesn’t matter if you’re dealing with a licensed mortgage agent or with someone who has a nice big shiny bank logo on their business card. You shouldn’t be putting your full trust in them by giving them your mortgage business until you have asked them a list of questions, or done your research on that individual. For all you know, they have only been in the mortgage business for a few weeks. LinkedIn can be a great tool in determining their experience level within the industry. The experience level of the person you are taking advice from is paramount.
Some mortgage professionals may be tough to get in touch with. I’ve heard of many instances where people have struggled to have phone calls or emails returned. Or it takes days to get answers to simple questions. They may promise a certain mortgage rate, pending management approval. Weeks may even drag by, only for them to come back with a higher rate. This happens all too often.
What are they trying to sell you?
Are they pushing you into a 10 year mortgage? Why? They’ll make a lot more on a 10 year mortgage,.. .but is that really right for you? Most people don’t even make it through 5 years, let alone ten.
- Are they pushing you to take insurance?
- Additional credit cards?
- Investments?
These are all products that make the banks money, and staff is often incentivized to sell them.
Case study
Jim and Mary are excited to be purchasing their first home. They contact a broker because of a low rate they saw online. The rate was lower than anyone else by far, so they apply. They follow up with the broker to find out the status of their application, but their calls are not returned. A week later, they get a hold of someoene. They are told that their application was just submitted to the lender, and they are waiting to hear back. Days go by, they follow up with emails but they are not returned, and when they are, they get vague answers. Another week passes and the mortgage commitment is finally sent to them dated three days earlier. They approval was in, but no one told the clients. They are told that they just need to provide a job letter and paystubs, with no other documents required. Two more weeks go by and the broker now tells them that they need to provide bank statements, which they do right away. Closing date is two weeks away. Another week goes by and the broker comes back with more requests. Jim and Mary follow up and cannot get in touch with anyone for another week. Now three days before closing, the broker gets back to them and tells them that she was on vacation and tells them that more documents are still required to close the deal.
Is this really worth saving $10 per month?
There is a lot of incompetence in this industry, and that applies to both the bank and the broker side. I can’t put enough emphasis on dealing with an experienced professional for your mortgage.
You may be inclined to put mortgage rate first, and in many cases you’ll be fine, but there are also many who may regret the decision. Some may not realize the importance of choosing the right person until they are put into a bad situation unfortunately.
Your mortgage is one of the biggest financial decisions you will ever make, so why trust it to just anyone?
2. Terms and Conditions
Once you have chosen the person you would like to handle your mortgage for you, the next most important consideration is the terms and conditions. The reason why this is more important than the rate is because it can significantly affect the cost over time. There is much more to a mortgage than just rate.
One of the most important terms is how the penalty is calculated if you find yourself in a position where you need to break your mortgage early. For example, the penalty to break a fixed rate mortgage with some lenders can be as much as 900% higher than others. This could mean the difference between a $5,000 penalty or a $45,000 penalty. The $10 per month you saved on rate wouldn’t mean a whole lot if you are slapped with an additional $40,000 in penalties for breaking your mortgage early. Just to be clear, there is not always this big of a difference in penalty. While a penalty of 900% higher is possible, it’s not that common. What is fairly common is a penalty that is 300-500% higher. Still pretty significant.
The major banks and some credit unions typically have the harshest penalties for breaking fixed rate mortgages. The monoline lenders generally have fair penalties. Note that a fair penalty lender still does not guarantee that your penalty will be low. If the rates when you break your mortgage are significantly lower than the rate you are currently paying, then you could end up with a high penalty regardless of which lender you are working with. Just not quite as high as it would be had you have chosen a harsher penalty lender such as a major bank.
The only way to be guaranteed a specific penalty is by choosing a variable rate mortgage, which will usually carry a penalty of three months interest. The operative word here is ‘usually’. There are some variable rate mortgages that will carry a penalty of 2.75 – 3% of the outstanding mortgage balance. A $500,000 mortgage at 1.60% would have a penalty of only $2,000 at three months interest. A 3% penalty would be $15,000. Significant difference. Terms and conditions are the most important thing to consider when choosing a mortgage product.
Common Mortgage Restrictions
On top of the penalty, there are a few other common restrictions found with some mortgages that you should be aware of:
Bonafide sale clause
This locks you into the mortgage for the full term, unless you sell your home. If you sell your home, then the restriction is somewhat meaningless. Outside of selling, you would not be able to break your mortgage early, even with penalty. This restriction is found in some mortgage products with MCAP, CMLS and BMO.
Variable rate compounded monthly
While all fixed rate mortgages are compounded semi-annually regardless of lender, variable rate mortgages can be compounded either semi-annually or monthly.
For example, let’s say you need a $500,000 mortgage with a 25 year amortization. You have two options, both at 1.80%. With semi-annual compounding, the monthly payment would be $2,069.32. With monthly compounding, it would be $2,070.93. Same rate, same mortgage amount, same amortization, yet one has a monthly payment that is $1.69 higher than the other. Not a huge difference, but it’s worth noting. Most borrowers wouldn’t even notice this unless it was brought to their attention. Most of the major banks use monthly compounding, as well as a few monoline lenders. If choosing a variable rate mortgage, always ask how the interest is compounded.
Limited prepayment privileges
While pretty much all mortgages have prepayment privileges, some will be more restrictive. RBC for example will limit you to a lump sum payment of only 10% of the original balance. On top of that, they only allow a single lump sum payment per anniversary year. On a $500,000 mortgage, this will allow you to prepay up to $50,000 per year without penalty. This is more than most will ever use, but the biggest issue here is not the amount. It’s the fact that you are limited to one time per year. If you make a lump sum payment of say $5,000, then you would not be able to make another until the next anniversary year. RBC is not the only lender with this restriction, so you’ll always want to ask if there are limitations to the number of allowable lump sum payments.
Many lenders have 20/20 prepayment privileges, meaning you can increase your payments by up to 20%, and/or pay up to 20% of the original mortgage balance per year as a lump sum. Often, there is no limit to how many times you can make lump sum payments, as long as they fall on a scheduled payment date. This allows for maximum flexibility. On a $500,000 mortgage, you would be able to pay up to $100,000 per year as a lump sum payment. If you were making accelerated biweekly payments, this would allow you to make as many as 26 lump sum payments each year. If broken up evenly, you can increase each payment by an additional $3,846. Or, you can break it up any way you like.
Higher than industry prime rate
At the time of writing, prime rate is 2.45%, which is used by the vast majority of mortgage lenders. Not all however. TD for example has a special ‘mortgage prime rate’, which is 0.15% higher than the rest of the mortgage industry. Prime -0.85% with most lenders would give you a rate of 1.60%. With TD however, prime -0.85% would be 1.75%. This is where you need to be careful. Most mortgage professionals, be it a broker or a specialist at the bank, will quote you the actual mortgage rate. Some people may tend to focus on the prime minus part of the rate, and this is where you can fall into the trap. If you’re offered a TD mortgage at prime -0.85% and have another option at prime -0.75%, it sounds as though the TD rate is lower. However it’s 0.05% higher based on the difference in prime rate. Always put your focus on the rate itself, not just on the discount off prime.
To make things even more convoluted, TD uses two different prime rates. They have a prime rate, and they have a ‘mortgage’ prime rate. Their prime rate is the same as everyone else. 2.45%.
Their regular prime rate is the one listed on their website, and one that comes up with a Google search. Their prime rate is not to be confused with their ‘mortgage prime rate’, which is the one that is 0.15% higher. To make things even more complicated, their Home Equity Lines Of Credit (HELOC) use the regular prime rate, even though a HELOC is still another form of mortgage.
Collateral mortgages
There is a lot of negative publicity about collateral mortgages, but they are not as bad as they used to be. In the past, to switch to a different lender at the end of the term meant you needed to proceed as a refinance, which would have meant a higher rate, in additional costs involved with proceeding as a refinance. Most lenders now offer collateral charge switches, which means you may still be eligible for lowest rates if switching lenders at the end of your term. The refinancing fees will still generally apply. The legal fee is approximately $800 (in Ontario), and there is also an appraisal fee of approximately $300. The good news is that there are lenders who will cover some, or even all of these fees for you. The bad news is that the rate is often 0.05% higher to have the fees covered.
Make sure you ask questions!
This why it’s important to ask a lot of questions. Restrictions may be glossed over, fluffed off, if mentioned at all. In some cases, the mortgage professional may not even fully understand them themselves. This is yet another reason why the choice of mortgage professional is one of the most important considerations when applying for a new mortgage.
3. Mortgage Rate
People generally look for the lowest rate as it’s the simplest concept to understand. The lower the rate, the more money saved. Mortgage rate is extremely important of course, and has a direct influence on how much you will save. However, the lowest mortgage rate will not always be the best choice, for the reasons mentioned above. Once you’ve selected the mortgage professional you want to work with, your next area of focus will be on the mortgage rate. The lowest rate won’t necessarily be the best option for you, but it’s a good place to start. Once you have all the details on whether it’s a fairly standard mortgage product, or if there are additional restrictions that could come back to bite you, you can then make a decision on whether or not the restrictions are acceptable in return for a lower rate. There are still many cases where the lowest rate might be available without any additional restrictions, or fairly close to it at least. A quality mortgage professional will point out these restrictions from the get–go and you can then make a decision as to which you think would be best suited for your situation.
4. Lender
While the choice of lender is important, it’s at the bottom of this list. I’ve already discussed rates and terms and conditions, which can often be used to rule out certain lenders. Some lenders can also have better service departments than others. I would personally never put a client of mine with a lender that I would not feel comfortable dealing with for my own mortgage, or if I were doing a mortgage for my mother. My reputation is far too important to me to take that chance. There are some who fall into this category. Most lenders however are pretty good to deal with.
There are some who believe that it’s better to deal with a major bank, however this is a fallacy. Just because you have heard of a specific lender does not necessarily make them a good choice. If you have not heard of a lender, this doesn’t necessarily make them a bad choice. Keep in mind, it’s the lender who is lending you the money, not the other way around. There are many myths about non-bank lenders, most likely spread by the big banks themselves. Sometimes banks will try to make it seem as though their money is of better quality than the money coming from other lenders. Some mortgage ‘professionals’ may even resort to providing flat out false information in attempt to deter you from taking your business elsewhere. Always verify what you’re being told if you find yourself in this situation. It’s very common.
One of the most common questions we get around lenders is what happens if the lender were to go out of business. If this happens, then their mortgage portfolio would get taken over by another lender. Your rate, and all your terms and conditions would remain intact. The only thing that changes is the logo that appears on your mortgage statement. You wouldn’t so much as need to sign a form.
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