Q: I am hoping to buy my first home. Should I go to my regular bank for my mortgage or are there better options available that you can recommend?
A: When you are buying your first home and getting your first mortgage, it can be an overwhelming experience. Even more so, with the current real estate market where you need to make decisions quickly and be able to get answers quickly. Most people think the only option is talking to the bank where they do their daily banking to get their mortgage.
The question is: Have you ever considered other options?
There are so many options besides getting your mortgage with the big 5 banks and credit unions. They are called monoline lenders, and these lenders only work with mortgage experts. The sole focus of these monoline lenders are mortgages and home equity lines of credit.
Mortgage experts have experience working with up to 200-plus lenders, including big banks, credit unions and monoline lenders. They understand the benefits of the various rate options, are familiar with the different types of mortgages and find the best mortgage for your unique needs.
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In comparison, if you approach your bank for a mortgage, they can only offer you a narrow choice of their own products, and those products may offer only limited choices in terms of features.
The following are features you should consider when looking for a mortgage:
The pre-payments without penalty clause is one of the conditions that can save you thousands of dollars over the life of your mortgage. This clause allows you to make payments on the principal of your loan, or increase the amount of your periodic payments (monthly, bi-monthly, etc.) without a penalty. Each lender has different programs for pre-payments, they usually vary from 10 to 20 per cent. For example, you can pay any amount within the approved percentage of the original value of your mortgage or increase your periodic payments once a year without paying a penalty. Many people don’t take advantage of this clause because it is generally difficult to save the extra money to make additional lump sum payments but they can certainly increase their payments up to 20 per cent. By doing this it will help you reduce your amortization period and pay more money toward principal than interest.
Collateral or Conventional Mortgage?
With a conventional mortgage, the amount you are borrowing (property value minus down payment) is the amount that’s registered. But with a collateral mortgage, the amount that's registered is 125-150 per cent of the property value, and the lender has both a promissory note and a lien registered against the property for the total registered amount.
The advantage of a collateral mortgage is easy access to credit. Since the mortgage is already registered for a larger amount than you need to buy the house, you can access additional funds in the future without any extra steps or legal fees.
However, there are also several downsides of collateral mortgages, especially if you are putting less than 20 per cent down payment. The reason is that, with the current mortgage rules, you are not able to refinance your mortgage unless you have more than 20 per cent of equity in your home. Therefore, unless your home dramatically increases in value in the next five years, you will not be refinancing anytime soon.
Free transfers or switches to a new lender when your term is up aren’t usually available. Most other lenders don’t like the fine print and restrictions of collateral mortgages and won’t accept them unless they are a refinance, which costs you legal, discharge fees and possible appraisal fees.
You could end up paying a higher interest rate at renewal. If your collateral mortgage makes it difficult to switch lenders at renewal, you don’t have the ability to shop around for the best rate. That could end up costing you up to one per cent more on your mortgage rate.
All closed mortgages have the pre-payment clause that says that is you pay off your mortgage before the end of the term, you would have to pay a penalty calculated based on the greater of the IRD (interest rate differential) or the three month interest penalty. However, there are some lenders that they are offering lower rates and in addition to the above penalties they are also including a 2.5 to 3 per cent penalty (depending on the lender), which ever one is greater. In addition, since there is no magic formula to determine the penalty, each bank has its own calculation formula. Most banks determine the rate you pay based on the posted rate minus the discount you receive. However, at the time to calculate the pre-payment penalty they use the posted rate.
When the lender uses the discount off the posted rate, it widens the difference with the comparison rate.
Here is an example:
- Mortgage amount: $300,000
- Current interest rate: 2.69 per cent
- Discount originally obtained from the posted rate 1.95%
- Months remaining on the term: 22 months
- Lender’s comparison rate: 3.04 per cent
One lender uses posted rates to calculate their IRD and the difference is 1.6 per cent. The penalty would be $8,800. The other lender uses only the contract rate, or effective rate, to calculate the IRD (the majority of the mono-lenders do). In this case, there is no discount that is used and the compassion rate for two years (using today’s contract rate) would be around 2.19 per cent. The difference would be 0.5 per cent and the penalty is only $2,750.
Remember: since mortgage experts have more options and are paid their fees by the lender (at no cost to you), before you start shopping for your home, contact a mortgage expert to assist you.