James
Pasternak, Financial Post
It is a
legal document that stretches about 30 pages and runs about 10,000
words. Its
execution takes no more than a couple minutes and when the ink dries on
the
signature lines, more times than not it is never read and gets slipped
into a
file folder, largely forgotten.
But
despite its casual handling, the residential mortgage agreement governs
the
largest debt of over 5 million Canadians and within its fine print are
the
provisions that can make or break a household's financial future.
There's a lot
at stake. At the beginning of 2004, Canadians held $517.7-billion in
mortgages.
"I think
most of the major bank representatives do a good job of explaining these
provisions to their clients but I think most people zone out and don't
really
listen. All they think about is getting a mortgage at 3.8% and ‘I want
to get
this done'," says Len Rodness, Partner, of Toronto-based law firm Torkin
Manes
(www.torkinmanes.com)
But
beyond the interest rate there are a wide range of options and clauses
in the
mortgage agreement that deserve scrutiny. In a competitive lending
environment,
shopping for the right mortgage can bring significant savings and peace
of mind
through the amortization period.
Take the
case of Hamilton, Ont., couple Kathy Funke and Dan Perryman. When they
were
shopping for a home in 2003, the interest rate was the top priority.
They also
wanted flexible prepayment options and accelerated weekly mortgage
payments. To
leverage the competitive interest rate they received, they went with a
variable
rate mortgage. They paid off a $230,000 mortgage in 5 ½ years.
"The
power in these things comes from people who know how to manage [the]
various
privileges. It has a huge [savings] effect on amortization....The ideal
thing is
to understand what your privileges are and then combine them to your
advantage
-- to what you can afford to do; to fit your lifestyle and ability to
pay," says
Jeff Atlin of Thornhill, Ont. based Abacus Mortgages Inc.
And
privileges there are. You just have to shop for them.
Accelerated
Payment Options: Getting the loan paid earlier
It just
seemed like yesteryear when everyone was paying their mortgage on the
1st of
every month. Now, in addition to the first of the month option, some of
the more
common options are accelerated weekly and biweekly or semi-monthly
options.
These
frequency options result in long term savings. For example if one
selects the
accelerated biweekly option one is making 26 payments in a year, the
equivalent
of two prepayments per year over the monthly option. When a $150,000
mortgage
amortized over 25 years is paid under an accelerated bi-weekly option,
the debt
is retired in 21 years and the interest savings are around
$18,000.
Toronto
resident and electrician Karl Klos, 26, selected "weekly rapid" payments
on a
mortgage amortized over 35 years. The mortgage payments are made each
week but
he added the "rapid" option by increasing the amount paid. Mr. Klos says
that
the payment frequency will pay off his mortgage in 25 years instead of
35 years.
"I can't
understand why anybody would do monthly payments anymore now that the
banks
offer the ability to have weekly payments. It may be a cash flow
situation. If
you do a weekly mortgage payment it could save you a significant amount
of
money," says real estate lawyer Len Rodness.
Restating
mortgage agreement vows
It
doesn't take long after one signs a mortgage agreement to hear from a
neighbour
or friend that they received a better rate. So when you dig out the
mortgage
agreement see if there's a clause that allows borrowers to renegotiate
their
agreement before the end of the term. The bank might use a model called
"blend
and extend." For example, if one has a $100,000 mortgage at 6% mortgage
with two
years to go they might blend it with the current five year rate of
3.79%. So
according to mortgage broker Atlin when they average out 2/5 of the
mortgage at
6% and 3/5 are at 3.79%, the customer will get a new reduced rate of
about 4.6%.
But the borrower is tied to the bank for another 5 years.
Putting
spare cash against the mortgage with no penalty
Almost
all mortgage agreements have options for mortgage prepayment without
penalty.
Klos's mortgage agreement allows prepayments of up to 15% of the annual
balance.
Most financial institutions provide prepayment options in the 10-20%
range. Some
lenders allow borrowers to make the prepayment any time during the year
while
other agreements restrict the prepayment to the anniversary date.
Also,
some financial institutions allow customers to make multiple smaller
prepayments
during the year as long as they don't exceed the annual limit. Funke and
Perryman were able to retire their $230,000 mortgage in 5 ½ years
primarily
because of the prepayment provisions in their mortgage.
Coming
up with more money for each payment
Some
lenders will allow borrowers to increase the payments without penalty.
Depending
on the wording of the mortgage agreement the increased payments can
range from
around 15% to 100% of the current payment. So if one is paying $1,000
per month
under the 15% rule, a borrower can raise it to $1,150 per month. Klos's
weekly
rapid payment plan was based on him raising the weekly payments by 5%.
"Payment
and amortization are a function of each other. Any time you raise the
payments
you shorten the amortization; any time you shorten the amortization you
raise
the payment," says Mr. Atlin.
The
mortgage prenuptial: Penalties for getting out of your mortgage
"A
mortgage is a contract first and foremost. It is a contract between a
borrower
and the lender," Atlin says. And if someone hasn't felt that cold
business
approach during the course of their mortgage, they certainly will if
they try to
leave early. Most borrowers pay out their mortgages when they sell their
house,
win a lottery or are offered a better interest rate by another company.
Until
recent years, the standard penalty for breaking a mortgage agreement was
three
months of interest. Paying out a $200,000 mortgage could amount to a
$2,500
penalty.
In many
current mortgage agreements, the penalty for an early exit (and not
extending)
is either three months of interest or an interest differential,
whichever is
greatest.
The
mortgage differential penalty can be quite expensive. If a mortgage is
at 5%
interest rate and you have three years left in your term, the bank will
use the
difference between the agreement rate and the current market rate to
calculate
the penalty. Using the 5% case above, let's say the current 3-year
mortgage is
available at 3.5%. The bank will charge the difference between 5% and
3.5% for
the balance of your term.
Bank
customers who have an open mortgage with a variable rate can usually pay
them
out with little or no penalty. Some mortgages are closed for the first
few years
and then revert to an open option. The penalties, if there are any,
would be
much lower once the mortgage converts to an open one. If one can, it
would be
best to wait until the mortgage kicks into open status.
When
paying out the mortgage try to have some of it calculated as your annual
no-penalty prepayment option. Therefore, if you are paying out a
$200,000
mortgage and you also have a 20% per annum prepayment option you might
be able
to save penalties on $40,000. If the mortgage prepayments can only be
done on
the anniversary date, make sure that is the day you select to pay out
the
mortgage.
Mortgage
Lifelines
Mortgages
are often signed and sealed with the borrower having every intention to
pay.
However, the world is paved with best intentions and recessions are
everyone
else's problem until the boss comes into your office with the bad news.
"That is
something that nobody turns their attention to at the time. The original
document is done. The legal issues are in that original document. For a
practical point of view given the state of the economy these [clauses]
might be
something beneficial," said Len Rodness of Torkin Manes.
Some
mortgages include a Rainy Day option. This option allows the borrower to
skip
one principal and interest payment each mortgage year. The interest
portion of
the skipped payment or payments will be added to the outstanding
principal
balance.
Read more: http://www.financialpost.com/personal-finance/mortgage-centre/story.html?id=2631845#ixzz0iTZkol9e