30 Sep

Renewing Your Mortgage?


Posted by: Brad Lockey

It is mortgage renewal time in my house.

I am one of those debt loving people who believe I can do more with my money by carrying a big debt at 3%, than by paying off my house and using up all that cheap capital – but that financial idea is a story for another column.

So, even though my mortgage comes due in October, I decided to lock in a rate four months earlier at a different institution at 2.79% for 5 years fixed. I was thrilled to have another five years of cheap money.

Even though I had already locked in elsewhere, I was interested in what my current mortgage lender would provide. I waited and I waited. Just four weeks before it was due for renewal they sent me a mortgage renewal notice. They could have sent it to me two or three months before my mortgage came due, but they may prefer to leave consumers less time to shop around and more inclined to just renew.

Here is where it gets interesting. “Please indicate which option you are accepting by signing your initials in the appropriate area indicated and return your signed agreement,” the letter stated.

I could just initial the 5-year fixed rate — for the princely rate of 4.79%.

Further on in the letter under a section called “Get the best rate,” it offered to extend to you our special interest rate hold guarantee provided if I signed by my renewal date. But all this says is that if the rate went down between now and about three weeks from now, I would get the lower rate.

This is a full 2% higher than what I am actually going to get somewhere else. If I had a $500,000 mortgage, this would cost me $47,600 more over 5 years by ‘just signing here’ vs. going to a mortgage broker three months in advance.

Just to be sure that I wasn’t missing something I called to make sure that I had the correct instructions and rate on my renewal. An interesting thing happened when I called. In about 30 seconds they said “I can actually get you a rate of 2.99% for 5 years.” I asked why my rate was 4.79%, and they said that this is the standard rate, but I can get this better special rate.

Doing the math, that phone call, using the same $500,000 example, would have saved me $42,800 over 5 years. That was a pretty valuable phone call.

I asked the kind sir on the phone how often people just sign the renewal form, and he said ‘quite a few.’

If a bank gets 5,000 people in the same $500,000 example to sign the renewal, that adds $42.8-million in profit to their bottom line each year.

Please do not automatically sign the friendly mortgage renewal form. At a minimum call to negotiate or call a mortgage broker to get the best deal for you. If you feel some sort of loyalty to your current mortgage provider, then be sure to see someone in person and ask for the very best rate that they give their very best customer. Your future net worth will be glad that you did.


23 Sep

What Financial Freedom Really Means …


Posted by: Brad Lockey


I’ve always been a saver. Even as a child, my pocket money was more likely to end up in my piggy bank than in my purse. I’ll admit that living in a remote English village with little opportunity to make impulse purchases probably helped.) But I’ve often wondered why I saved.

My savings tended to build up and never be spent. I lived within my means. But I never had a use for all the money I was saving; I never knew why I was doing this. Then, last Christmas, I discovered what financial freedom really means.

My younger brother has been ill for as long as I can remember. From birth, he had complex medical needs, as well as physical and learning disabilities. He spent much of his first few years in hospital, and was frequently rushed back in with serious infections, or deterioration of his medical conditions. Over the years, these emergencies became less frequent, partly due to advances in medical care, and partly because we were better at managing his health out of hospital. However, I always knew that the call might come.

Last year, my brother became increasingly unwell. He was on antibiotics a lot of the time, and his quality of life was decreasing. Although we didn’t want to think about it, we knew that he was nearing the end. In November, he was admitted to hospital with a severe infection, needing more intervention than he could get at home.

I couldn’t cope with living so far away when he was so ill, so I arranged to go up and see him. I paid a hefty last-minute train fare, and took time off work, knowing that it would probably count as compassionate leave, but prepared to take unpaid leave if I needed to. I knew I could afford it. My brother improved, was discharged, and I came back to work. I had taken the maximum number of days off that my employer allowed for compassionate leave.

However, the following weekend, my brother was rushed back into hospital by ambulance, and it was clear that this time it was life-threatening. I again rushed back, explaining things to HR on Monday morning. My brother died a week later, just before Christmas. He was 29.

Due to the holidays, we couldn’t hold the funeral until the new year, meaning I took over a month off work, only two weeks of which was covered by my pre-booked annual leave. I wasn’t able to use my pre-booked train ticket, and had bought two expensive last-minute tickets, on top of extra clothing as I’d come home with just a couple of changes of clothes. As far as I knew, I had also “used up” my allowance of compassionate leave.

That’s when I realized what financial freedom means. Because I had been saving for a life-time, my costs didn’t matter. If I had to take the time as unpaid leave, it wouldn’t actually impact my budget. I had the cushion to take it. I could take the time to grieve and recover without worrying about the money.

In the end, the costs weren’t as bad as I anticipated. I was able to get a refund on the unused pre-booked train tickets, and was given “discretionary” compassionate leave to cover the extra time. But I didn’t find that out until later. Knowing I could afford the worst-case scenario gave me peace of mind when I most needed it.

22 Sep

It’s taxes versus a mortgage for the self-employed


Posted by: Brad Lockey


Eighty of mortgage broker Dustan Woodhouse’s clients who were approved for a mortgage in 2011 wouldn’t have qualified for the same mortgage today.

In the summer of 2012, Canada’s financial regulator introduced Guideline B-20 as a way of tightening up the banks’ approval processes.

Part of B-20 requires banks to examine incomes more closely, but where does that leave self-employed people, who have had more trouble getting mortgages since that rule was brought in?

“It sort of came in under the radar a little bit and caught a lot of [self-employed] people off guard when they were probably not used to having any real issues with arranging financing in the past,” says Gerry Orr, president and owner of Alberta Mortgages in Calgary.

The main problem for self-employed workers is that they typically lower their taxable income through business expenses and other deductions, so what they declare is often an inaccurate reflection of their true incomes. In the past, they were able to simply declare their incomes and provide proof of self-employment, along with other documentation.

Today, self-employed individuals can still apply for a stated income mortgage at some banks, but B-20 also means that they need to put up at least a 35-per-cent down payment to avoid purchasing default insurance from the likes of Genworth Canada or Canada Mortgage and Housing Corp., Canada’s two largest mortgage insurers.

So while those 80 families of Mr. Woodhouse, an accredited mortgage professional with Canadian Mortgage Experts in Vancouver, can consider themselves lucky that they were approved before B-20 was put in place, what about other self-employed individuals or families in the current climate? What can they do to ensure that they can obtain the kind of mortgage they need?

According to many experts, it all starts with how much income you’re declaring when you file your taxes.

“The key is to declare as much money as possible and not hide funds by any means because it’s going to hurt you in the long run,” says Mathieu McCaie, a mortgage agent for the Mortgage Group in Dieppe, N.B. “You’re either paying Revenue Canada or you’re paying it somewhere else to borrow the money, basically.”

And while prospective self-employed homeowners will have to submit a detailed, accountant-prepared general tax form, in full – not just the four-page summary that many people turn in – in addition to a notice of assessment to confirm that no taxes are owing, it’s one thing in particular that prospective lenders are looking for.

“Line 150 – documented income – is everything,” Mr. Woodhouse says. “That’s also the composition of that income. What they’re really looking for is earned income from your trade or your profession.”

With that in mind, how much income are they looking for?

“Typically, if someone’s operating a fairly successful business, they should at least claim $100,000 or just under if they want to continue purchasing real estate,” says Michael Marini, a mortgage broker with Dominion Lending Centres in Toronto.

“If it’s just for their own single purpose, just one purchase, they need to show an average two-year income. They need to ensure that their income is high enough in the last two years to qualify for the property that they want.”

With that two-year period in mind, planning is of the essence. Purchasing real estate and establishing a successful business do not necessarily mix in the short term, so you’re better off building up your business before deciding to buy a house, experts suggest.

“If you’re not two years in the business, that’s going to be a real challenge to purchase a house,” Mr. McCaie says.

For those who don’t qualify via the banks and other A-list lenders, there are other routes, such as credit unions, that are not subject to the B-20 regulations and can take on more risk from their borrowers.

“Through alternative lending channels we can use gross income by showing bank statements that show you have income coming in, you’re just not declaring it, and give them a mortgage,” he says.

Such a loan might come at a higher cost, however.

“Really, it comes down to whether or not you’re willing to pay the interest premium and the higher down payments required with a B or private lender, versus arranging your affairs in such a way that your income personally on your notice of assessment reflects a higher level,” says Mr. Orr.

Or, as Mr. Woodhouse puts it, would you rather pay a premium on your mortgage, or would you rather pay income tax? “It’s your choice.”

5 Sep

Light Friday Financial reading on Interest Rate Differentials


Posted by: Brad Lockey

Many people think that the differences in how lenders calculate fixed-rate mortgage penalties are a non-issue now that rates have fallen to ultra-low levels. But nothing could be further from the truth.

In actual fact, the relative cost of how penalties are calculated is never more pronounced than when fixed-mortgage rates stay flat or rise slightly over an extended period – exactly the scenario that many experts predict will unfold in the coming years.

Fixed-rate mortgage penalties are almost always calculated based on “the greater of three months interest or interest-rate differential (IRD)”. But there are key differences in the actual rates lenders use to calculate your IRD. I will show you how these differences are magnified in a flat or slightly rising interest-rate environment. And we’re not talking small potatoes here – today the IRD calculations used by some prominent lenders can trigger a penalty that is more than four times what you would be charged at a wide range of other lenders.

Let’s start by assuming you have a current balance of $250,000 on a five-year fixed rate mortgage at 3.29%. We’ll also assume that you are three years into your term (with two years remaining) and that interest rates are the same when you break your mortgage as they were when you first got your loan.
First, we calculate the cost of three month’s interest, which we can quickly determine is $2,056.25 Here is the formula we use to come to that number:

3.29% X $250,000 X (3/12) = $2056.25

We then compare this cost to the cost of your IRD penalty, which will generally be calculated in one of three ways: Standard, Discounted or Posted.


The Standard IRD Penalty

When using a standard IRD penalty calculation, your lender starts by taking the difference between your contract rate (3.29%) and their current rate that most closely matches your remaining term. Since you have two years left on your mortgage, that would be the lender’s two-year fixed rate (we’ll use 2.99%, which is widely available today). The difference between these two rates is 0.30%. The lender multiplies this difference (0.30%) by your mortgage balance ($250,000) and the time remaining on your mortgage (expressed as the number of months remaining on your mortgage divided by twelve). Here is the complete formula:

(3.29% – 2.99%) X $250,000 X (24/12) = $1500

That’s it.
If you understand this example, then you have mastered the standard IRD calculation and I congratulate you (take the time to applaud yourself please). It is used by a wide range of monoline lenders who compete with each other to offer borrowers the best mortgage rates available.
But here is where a little knowledge can save you some serious money. Other well-known lenders (BANKS) have tweaked their IRD calculations to skew the interest rates used in their formulas heavily in their favour, and as you will now see, that can have a huge impact on the size of your penalty.

The Discounted Rate IRD Penalty

When using the Discounted Rate IRD Penalty, the lender takes your contract rate and compares it to the posted rate that most closely matches your remaining term MINUS the original discount you got off of their five-year posted rate (which in this case is 1.95%). Here is the contract wording taken straight from a well-known lender’s website. I have bolded the key section:


[Your contract rate will be reduced by] the current interest rate that we can nowcharge for a mortgage term offered by us with the term closest to your remaining term. The interest rate will be our posted interest rate for the term minus the most recent discount you received.
In other words, this lender will take the discount they gave you off of their five-year posted rate and apply that same discount to the posted two-year rate they use in your penalty calculation. This tweak makes a big difference to the cost of your penalty and is blatantly one-sided because lenders don’t discount shorter-term fixed-rate mortgages nearly as deeply as they do their five-year terms. This tweak is introduced only to artificially lower the rate used in your IRD penalty calculation.

Here is the complete Discounted Rate IRD penalty formula:

(3.29% – 1.60%*) X $250,000 X (24/12) = $8450 * 3.55%-1.95% = 1.60%

But just you hold your horses and keep reading because other major lenders dig even deeper into your wallet and long term financial plans. The Grand Daddy of them all is the Posted Rate IRD Penalty.

The Posted Rate IRD Penalty

In this variation, the lender calculates your IRD penalty using the five-year posted rate that they were offering when you got your mortgage. Here is a sample of the wording used to explain how the penalty is calculated (taken from a well-known lender’s website yesterday). I have bolded the key sections again:
The interest rate differential amount is the difference between the Interest on the Prepaid Amount for the remainder of the term at the posted rate at the time you took out the mortgage, and interest on the Prepaid Amount for the Remainder of the Term using a Comparable Posted Rate. Interest is calculated at the interest rate posted by [the lender] for a mortgage product similar to your mortgage product on the date the payout statement is prepared.
Now a lender’s (BANK’s) common defense of this tactic is that they substitute posted rates for both your original rate and the rate that most closely matches your remaining term. But as we already outlined above, this is a terrible trade that no informed person would accept because lenders routinely give huge discounts on their five-year fixed-mortgage rates, and those same discounts shrink dramatically on shorter fixed-rate terms.
Here is what that tweak to the wording in your contract does to your penalty:

(5.24%* – 3.29%) X $250,000 X (24/12) = $9750

Surprised? Don’t be. These inflated mortgage penalties generate substantial profits for the lenders who use them and when uninformed borrowers choose to negotiate directly with their lender, is it that hard to imagine that some of those lenders would tweak the fine print in their favour?

To be clear, I don’t have a problem with mortgage penalties in general. When you break a mortgage contract, your lender incurs costs when they unwind agreements related to your loan. The penalty charged is supposed to cover these costs while also recoup part of the lender’s lost profit. Fair enough. That’s why they’re called “closed mortgages”. But is it fair for some lenders to use these early terminations as “gotcha” moments?

I don’t think the vast majority of Canadian mortgage borrowers have any idea that there are significant differences in the way fixed-rate mortgage penalties are calculated, and the largest Canadian lenders, who have milked that lack of awareness to their advantage for years, have been in no hurry to explain it to them.

On a more positive note, this is finally starting to change. Federal Finance Minister Flaherty called for better disclosure of how mortgage penalties are calculated in his 2010 budget, and slowly but surely, lenders have started spelling out their penalty terms in more detail. That makes the information more accessible for borrowers who are prepared to do the complicated due diligence. Or, if you’d rather not sort through the legal mumbo jumbo and do the calculations yourself, a conscientious and well informed

independent mortgage planner (like Brad Lockey) is able to explain the penalties charged by any lender they are recommending. Forewarned is forearmed.

If you made it to the end of this blog post then you deserve to share it with someone; please do so. As always, your comments and suggestions are more than welcomed.

Enjoy your weekend.