There has been absolutely no change to the Bank of Canada's overnight lending rate, and as a result of an extremely uncertain outlook on not only the Canadian economy itself but the global economy as well, major banks are cutting their interest rates.
Yesterday, Royal Bank of Canada was the very first bank to cut it's five-year fixed rate 10 basis points from 3.89% to 3.79%. Here at the broker channel, interest rates have also been reduced by various lenders all across the board.
This is great news for mortgage borrowers who have been anxious about rapidly increasing mortgage payments on a variable rate mortgage or for those who have mortgages coming up for renewal.
Any other variable rate credit products will also maintain the same payment assuring borrowers that payments will stay manageable for the short foreseeable future.
What's causing the sudden change of heart by the Bank of Canada?
Just a couple of months ago we were hearing that 2019 was the year for rate increases. But last week, the Bank of Canada took a sharp turn and held the overnight lending rate at 1.75% signaling that the economy is not as strong as they thought it was.
So you know, the Bank of Canada's job is to maintain stable pricing and low inflation. And, much of the decision with respect to the overnight rate is based on oil and global uncertainty as well as turmoil in Canada itself (transportation issues surrounding getting oil out of the country is causing a surplus).
Perhaps the wonderful economy is not as strong as expected and the Bank of Canada needs to revise how they are looking at things going forward?
Additionally, the US Fed has also changed their tune largely because global growth is not as strong as they hoped such as tariffs being one hurdle they are approaching.
And then there's the 'yield curve' that is flattening aggressively and this tends to signal a recession is on the horizon. Some economists also suggest 2020 is just around the corner and may be a recession year.
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If you prepay the entire balance of your mortgage loan before the end of its term, there will be a penalty to do so (i.e. exiting your mortgage in year 3 of a 5-year term).
Here are reasons borrowers exit their mortgage term early:
1. They sell their home.
2. They refinance with another lender.
3. They pay off the balance with inheritance or personal savings.
In order for your lender to calculate your penalty, they must follow a formula. Some lenders use a more expensive formula than others, and as a result, it is always beneficial to sort out how the lender’s penalties get calculated BEFORE you sign a mortgage contract. Of course, this exercise is necessary for any borrower who wishes to save money over the long haul. This is precisely a case of “failing to plan, planning to fail."
Here’s an example of a clause from CIBC Mortgages showing how a mortgage penalty will get calculated should the borrower exit their contract early:
If you have a fixed rate closed mortgage, your prepayment charge will be the greater of the following:
Three months worth of interest is easy to calculate, and using your interest rate, you can determine, at any point during your mortgage term, what the penalty will be. What you won’t know, however; is what the Interest Rate Differential calculation will be and if that will be higher than the three months worth of interest.
(If you have a variable rate mortgage, the penalty will always be just 3 months worth of interest).
How do you calculate the “Interest Rate Differential?"
The Interest Rate Differential or “IRD“ (in mortgage lingo) is based on the total amount you are prepaying. Here, the entire balance is being paid off.
The Penalty will equal the mortgage balance x Differential amount x the total months remaining DIVIDED by 12 months.
So, for example,
$100,000 mortgage with an interest rate of 9% with 24 months remaining.
The lenders’ current rate is only 6.5%
The differential is 2.5% (9-6.5%)
The issue with posted rates is they are not all the same and the higher the posted rate, the more expensive the penalty can be. BIG Banks (Royal Bank, TD Bank, CIBC, Bank of Montreal, Scotiabank, National Bank, etc.) all use the Bank of Canada’s POSTED RATE to calculate their mortgage penalties.
None of these financial institutions, however; actually charge the client the posted rate on their mortgage loans. What the bank does instead is provides a discount off of the posted rate, which is then used in lieu of the current discounted rates they are offering to calculate the penalty.
So for example, if your rate is 3.64%, but the posted rate at the time of the mortgage was 4.84%, they use the discount of 1.2% (4.84-3.64).
When it comes to smaller outfits or "monoline lenders" accessed exclusively through the broker channel, they often have similar prepayment penalty formulas except they plug in different numbers. Monoline lenders tend to use lower posted rates (not the Bank of Canada‘s) to calculate their penalties.
So, for example, if you’re rate is 3.64% and the monoline‘s (broker-channel only) posted rate is 3.99%, the discount is only 0.35%. One can see how this would equate to a lower penalty when entering these numbers into a basic formula.
Using a mortgage balance of $280,000 at a rate of 2.99%, taken out on September 1, 2016, and maturing August 21, 2021, let‘s take a look at the difference in calculation based on the borrower exiting January 15, 2019.
With CIBC Mortgages:
Calculation type:Interest rate differential
Learn more: Information on mortgage prepayment (open in a new window)
Remaining term:2 year(s), 8 month(s)
Comparison rate:3 year, 3.940%
Current Interest Rate:2.990%
Rate discount received:1.850%
including cash back:$6,675.84
With a monoline lender (First National Financial LP)
(Example of calculation below)
Your estimated prepayment charge is
There is definitely no debate about which lender has a better prepayment calculation.
Sometimes borrowers feel comfortable sticking to a major bank out of security and safety. It is a myth that big banks are safer than monoline lenders. If your lender should go bankrupt, they’ve already given you the money!
The proof is always in the pudding, and the argument about prepayment penalties is clear.
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Sarah A. Colucci
I have over a decade of mortgage experience. I am passionate about helping my clients obtain the best mortgage and getting out debt as soon as possible.