You bought your brand new house five years ago and you thought then that it would take forever to pay. You chose the five year fixed plan because you wanted to have a fixed amount to shell out monthly, instead of swaying with the fluctuating interest rates based on prime. Following prime would be too much of an uncertainty, especially with the kids in school and the in-laws needing financial help every now and then.
Before you know it, the five years are up and your bank just sent you a notice saying it’s time to renew the mortgage. You sit down and stare at the renewal notice, turn on your computer, try to research some figures and crunch them, but you start feeling like a dunderhead because there’s just way too much information about renewing a mortgage. You chide yourself and say, “c’mon, you’ve been through the first round, why should the second time be difficult?”
Choices, that’s why. Innumerable choices are there for the asking. It’s like picking a good cheese out of 240 or so varieties. Okay, maybe mortgage options don’t number as high as 240, but you’ve seen the bank leaflets that introduce a dizzying array of choices. It’s consumer mania in triple action!
Renewing a Mortgage: Which Way to Go?
First off, know what type of mortgage you want:
- Closed
- Open
- Convertible
These three types are fairly standard mortgage terms used by most banks and lending institutions. The terms may vary slightly, but when you talk about a “closed” or “open” mortgage, most people will usually know what you’re referring to. Still, it won’t hurt to refresh our memory:
Closed mortgage – according to many banks, the closed mortgage is the ideal choice for home buyers who plan to stay long term in their homes. It is also considered the ideal choice for first home time buyers, especially in the initial years of the mortgage. In closed mortgages, the interest rates are usually lower; home buyers are secure in the knowledge that they have a fixed mortgage payment every month and can control their monthly budget. As for the amortization period (the number of years it will take for the mortgage to be paid in full), home buyers have a choice of choosing anywhere from six months to 25 years for a closed mortgage.
Open mortgage – a type of mortgage that can be prepaid at any time without penalties. One would choose this mortgage if there is a strong possibility of a short term move. The only disadvantage is that interest rates may be higher for open mortgages – a price to pay for the flexibility factor.
Convertible mortgage – this carries the same degree of security as a closed mortgage, but there’s the built-in flexibility added. This flexibility allows you to convert your mortgage into a longer term closed mortgage at any time without incurring any penalty fees. If you monitor rates closely and want to optimize on fluctuating market trends, you can wait until the rates go down before you convert and consequently lock in your rate.
Renewing a Mortgage: Fixed or Variable?
Mortgage lingo is used all the time – newspapers, flyers, magazines, and the Internet talk about mortgages almost daily. So words like fixed or variable, since they’re used ad nauseam, are self-explanatory.
A fixed-rate mortgage, as everyone knows, is a rate that is locked in for the entire life of the mortgage. Payments are fixed amounts so you can properly budget your monthly monies. You can select an open fixed-rate mortgage (may be paid off any time without penalty or breakage costs) or a closed fixed-rate mortgage (you pay penalty charges for breaking the term of your mortgage).
As for the variable rate mortgage, your mortgage payments are pre-established for the term of the loan, although interest rates may fluctuate during that time. If the rates go down, more of your payment is applied to decrease the principal, but if the rates go up, more of the payment goes to pay interest. Note that variable rate mortgages may be open or closed.
Home buyers who have opted for a variable rate mortgage have been able to enjoy lowered interest rates during the building boom in the early 2000s. The variable rate mortgage, however, can be disadvantageous when rates trend up. Witness what happened in the United States when rates inched higher, sending the home market into a tailspin. Tens of thousands of home owners filed for bankruptcy, their houses making it to the foreclosure process.
Banks generally allow mortgagees to shift from a variable rate mortgage to a fixed rate mortgage at any time. Some banks also introduce their rate capper mortgage packages where you are protected even if rates reach a certain level. For example, if you chose the rate capper, your rate could fluctuate, say from 4.5% to 6.5%. Your ceiling is capped at 6.5%, so if rates go to 6.58%, you only pay up to the maximum of 6.5% interest.
Renewing a Mortgage – A Lower Rate May not Necessarily Be Better
The tendency of most homeowners when their mortgage is up for renewal is to look for another bank or lending institution that will offer a lower interest rate, even if the difference is a few percentage points. We’ll cite our personal experience as an example:
When we bought the property four years ago, it was a great time for individuals buying their first homes because the interest rates were so low. It would have been silly to remain a renter. We managed to lock in a mortgage rate of 4.84% – an excellent rate at the time – for a term of four years. Two months before our mortgage fell due, we shopped around for the lowest possible rate and we managed to get a special 5.14% rate from another bank (bank B) that we also do business with. Based on our research, this was a good rate because the posted rates of most banks were offering 6.3%, 6.4% and 6.5% for a fixed five year term mortgage.
Tip: when you go on the web sites of banks, they normally post their rates for the general public. Then right below these rates are their preferential rates (rates that they offer to preferred customers)– usually 1 to 2 points lower than regular rates. However, if you have a special relationship with the bank or have been banking with them for many years, they give you even a much rate than their preferential rates and they’re usually not advertised.
The bank (bank A) where we had our mortgage offered us 5.19%. In principle then, since we were shopping for the lowest possible rate, we could transfer our mortgage to bank B who was quoting us 5.14%, enabling us to take advantage of a difference of .4 points.
Here’s the catch: if we transferred our mortgage to bank B, sure we would be getting a lower interest rate, but since it’s not even a full percentage point (.4 is a far cry from 1), the difference in actual dollars would have been only $50.00 odd a year. To us, however, the biggest hindrance was doing the notary bit all over again; that is, book an appointment with the notary, get to his offices physically, sign the papers and then change our banking arrangements with bank B. This meant spending the extra time and effort just to knock off $50.00 annually.
We stayed with bank A in the end. We didn’t have to meet with a notary and didn’t have to make any changes to our checking or savings accounts. By staying with bank A, we saved plenty of time. We simply went to the bank, met with the bank officer, signed the renewal notice and then shook hands – a process that took seven minutes at most.
So when the time comes for renewing your mortgage, pay attention to other factors, not just the lower interest rate. If obtaining a lower interest rate means more time and effort on your part, and the change is negligible, why rock the boat?
