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Mortgage Borrowing Cost

Your guide to mortgage borrowing cost.

About mortgage borrowing cost

Most homebuyers set out to secure the lowest mortgage rate possible. And you can’t blame anyone for that.

But snagging the lowest rate doesn’t always translate into the lowest overall borrowing cost. Not over the full life of your mortgage anyway.

In fact, a lower rate could even end up costing you more. Below we explore why.

Interest rate vs. overall borrowing cost

Survey after survey confirms that a large majority of borrowers make interest rates their top priority when choosing a mortgage product. A recent RATESDOTCA poll found that three out of four mortgage shoppers (75%) say getting a low rate is an important factor when choosing their mortgage.

Contrast that to the mere 1 in 5 (19%) who said achieving the “lowest overall borrowing cost” is their main goal.

Borrowing costs refer to the total expense associated with getting and paying a mortgage. That includes interest, fees and penalties, among others.

The latter, penalties, is often the factor most overlooked by borrowers. And that’s dangerous because it’s the one that can cost the most.

The lowest rates usually mean less flexibility

The reason for this is simple. There’s no free lunch.

Many of the lowest mortgage rates on the market are “no-frills” products. That means they typically include greatly reduced features and flexibility. That saves the lender money, which saves you money upfront.

Unfortunately, it’s a saving that often comes back to haunt you later.

Here’s a look at some of the costs associated with no- or “low-frills” mortgage products as a result of their non-existent or scaled-back features:

  • High mortgage penalties for refinancing or breaking your mortgage early
  • Penalties if you can’t meet the lender’s rigid porting restrictions
  • High rates when existing customers try to refinance before maturity
  • High rates when existing customers try to convert a variable rate mortgage to a fixed
  • High rates when existing customers try to renew
  • Penalties if you need to increase your mortgage before maturity
  • Prepayment restrictions that force you to pay more interest
  • No ability to renew early (a potential problem in a rising rate environment)
  • More costly compounding on floating-rate mortgages
  • High discharge fees, reinvestment fees
  • Less favourable registration methods — e.g., collateral charge mortgages, which are inappropriate for many because they entail higher legal costs.

Choose your mortgage wisely

Mortgage borrowers should give serious consideration to the features that are (or aren’t) included in the mortgage they’re about to secure.

Prepayment penalties are often the biggest rate-savings killers. Some of the penalties listed above can easily cost a borrower three or four times the interest rate savings they achieved by choosing the lowest interest rate.

For example, suppose you move to a new home and your closing date is 60 days away. If your lender only allows 30-day ports, you have a problem. You could be stuck paying thousands in prepayment fees and/or lose your pre-existing low rate.

More flexible porting policies allow 90 to 120 days (some allow up to 180). But that flexibility comes at a cost, a higher rate. Although, paying a 0.10-percentage-point higher rate on the average mortgage (which is statistically about $300,000, as of June 2021) amounts to just $1,400 over five years. A prepayment penalty on that $300,000 mortgage can easily range from $1,500 to over $10,000! Sadly, too many Canadians are penny-wise and pound-foolish when it comes to rates and penalties.

The same reasoning applies to lenders that don’t let you refinance elsewhere before maturity. Lenders with restrictive refinancing rules might leave you stuck with a rate that’s a quarter-percentage-point above the best market rates, for example. A quarter-point on a $300,000 mortgage is $3,500 of extra interest over five years.

A no-frills mortgage can be priced anywhere from 10-20 basis points below the best full-featured mortgages. But the trade-off could include features or restrictions that cost you two to four times that amount. Some low-frills lenders impose 3% of balance penalties instead of standard full-featured penalties of just three months’ interest, for example. That could essentially result in our borrower with the $300,000 mortgage paying $9,000 in prepayment charges to save $2,800 or less in interest.

Now, to make a proper decision you need to assign probabilities to you needing a particular feature. If you’re 100% sure you’ll never move, for example, portability may be a moot point. (Although, we’ve never met a homeowner who could be 100% sure of that.)

If you’re thinking there’s only a 25% chance you need to refinance early, then a refinance restriction that could cost $3,000 might only cost you 25% of that ($750), on an expected-value basis.

The message here is that borrowing costs matters. And it matters more than virtually anything else, apart from getting approved, perhaps. Fixating on the lowest rate without first assessing your five-year plan is never advised. You’re usually better off paying a little more to limit your mortgage costs after closing. That is, unless you find a mortgage unicorn: the lowest possible rate and all the bells and whistles.

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