We’re all used to seeing or hearing ads stating that this bank or that lender has the best interest rates available. We’ve all also been at a social gathering where people are bragging about how low their interest rate is. But, there’s a lot more to a mortgage than just an interest rate. There are also reasons why the interest rate is the main feature that’s advertised by lenders. We’ll get into a few reasons why this is the case. If interest rate is your only mortgage consideration, this is especially for you.

Rates

Lenders like to advertise rates because this is something that the average borrower understands. For example, most people will have no issue calculating or understanding that 1% of $100 is $1. But, how many people are comfortable calculating the penalty to break a mortgage before the end of its term? Ever heard of IRD (Interest Rate Differential)? If you have, great, now explain how its calculated. Some of you high-achievers will, but its somewhat of a trick question since lenders have different methods of calculating IRD. See my point? By quoting a low rate, lenders are able to ‘dangle the carrot’ in front of borrowers. These low rates attract attention much like Prime Day for all you Amazon shoppers. What’s not directly advertised is who qualifies for the advertised rate as well as the options that are or aren’t attached to that mortgage. Let’s talk about some of the common options attached to a residential mortgage and why the lowest rate could cost you more of your hard-earned cash down the road. Let’s face it, we don’t need any more hands in our pockets these days.

Penalties

Let’s talk about penalties. In order to break your mortgage prior to the end of its term, there are generally two methods of calculating the penalty. Calculating three month’s interest is self-explanatory. IRD is where things start to get a bit complicated. In simple terms, the IRD calculation uses your current interest rate and compares it to another rate that the lender sets. This rate could be the current posted rate, a 3 year bond rate, etc. Depending on the rate that the lender uses and the time left to maturity, the penalty can be massive. Its vital for borrowers to know this info and its my job as a mortgage agent to inform and guide you. Where am I going with this? You may be looking at a number of lenders who have similar rates and you decide that you’ve narrowed your choice down to two. Lender A has an available rate of 5% that you qualify for and Lender B has a rate of 5.05%. On the surface this seems like a no brainer, right? Not so fast young Jedi, these aren’t the rates you’re looking for. Both lenders use 3 months of interest or IRD to calculate penalties. Lender A with the lower rate uses an IRD rate that is far less advantageous to you as a borrower. This would result in a much larger penalty to break the mortgage. Now, I know you’re saying, “Mike, I have every intention of holding my mortgage until maturity”. Most people believe this. Reality is that the majority of mortgages in Ontario are renegotiated prior to maturity, resulting in a penalty. This can be due to many things including life events that are out of our control. So in this case, the lower rate may cost you more in the long run.

Pre-payment

Next, let’s move on to pre-payment options. Over the past 10+ years, we’ve become accustomed to a low interest rate environment. Given the choice between investing money or pre-paying your mortgage, most people were opting to invest. Low interest rates combined with sustained growth in the stock markets provided investment returns that could easily beat interest rates on mortgages. Unfortunately, that may no longer be the case with inflation, increased cost of living and rising interest rates. Why is this important? Well again, lets take the same two mortgages from above. Lender A has an interest rate of 5%, but offers no pre-payment privileges. Meaning, the only potential way to pay off that mortgage without penalty would be on a bona-fide sale of your property. Lender B charges a slightly higher rate, but allows an annual pre-payment privilege of up to 15%. Now, you may say, “I don’t have any extra money to pay down my mortgage”. Well, my response to that would be a question. Do you know for certain that you won’t have extra money to pay down your mortgage in 2 years, 3, 4, etc.? Maybe paying off your mortgage quicker isn’t a priority for you, but this is just one option. Again, for a small difference in interest rate, you now have options to accelerate how quickly you pay off your mortgage.

Porting

Lastly, portability. This is the ability to move or ‘port’ your mortgage at its current rate and terms to another property. This can be important if you’re looking to move and interest rates are on the rise or are higher than your current rate. This option is often overlooked by borrowers because many people decide to move at the most unexpected times. Again, this could be through a life event or because you simply fell in love with a property and you need to have it. This option can work in the borrower’s favour. But, as with all lenders, they want to secure their interest and will in turn charge a premium on the interest rate.

By no means is this an exhaustive list. These are just a few of the most common options available to borrowers. Hopefully this gets you thinking about your mortgage in ways that you didn’t in the past. I think you can see that mortgages are a lot more complicated than just an interest rate. But this will get you thinking about something other than rate. If this seems complicated, its because it is. There’s always a fine line between the options you need and the rate. A professional mortgage agent will help you find that line and guide you through financing the largest purchase most people will make. If you don’t have a professional mortgage agent in your corner, its time to think about why you don’t.