I've noticed that most mortgage clients aren't aware of the different options available to them like switching their mortgage. In this article, I thought we could review the mortgage switch. To start with, can you switch your mortgage to another bank?
Yes, you can switch your mortgage from one bank to another bank either during the term or at the end of the term. To switch during the term there's typically a mortgage penalty. To switch at the end of the term there is no penalty or you can also choose to renew with your bank or to pay the mortgage balance in full.
To set a little bit of the ground work. I want talk about the your mortgage and what you can do with it during the term and at the end of the term.
Your mortgage is a contract between you and the bank that you are dealing with.
The contract will have a term, that is the time frame that applies to your mortgage. For example, your mortgage could be set up for a 5 year term or a 3 year term. The term typically dictates how long you are guaranteed a specific interest rate or in the case of a variable mortgage, how long you would be guaranteed a discount to the prime lending rate.
The contract will also involve an amortization. That's how long it will take to pay off your mortgage. For most people the amortization is 25 years.
During the term, you can break the contract 4 different ways:
- by paying the mortgage off early (with cash)
- by selling the home (your lawyer would send cash to the bank on the sale date)
- by switching the mortgage to another bank (the other bank pays cash to the first bank on the closing date)
- by refinancing the mortgage with your current bank or a new bank. (the existing mortgage is paid out and a new, bigger mortgage is set up)
When you break the contract, then there may be a penalty. I talked about penalties and how they are calculated in another article, you can read that article here.
At the end of a mortgage term, you also have 4 options:
- you can renew the mortgage with your current bank for a new term (1 to 10 years, your choice)
- you can switch the mortgage to a new bank and choose a term from 1 to 10 years
- you could pay off the mortgage in full without penalty
- you could make a lump sum payment (in excess of the pre-payment privileges and either switch or renew the mortgage after the lump sum is applied to the balance)
Now that we've talked about what you can do with your mortgage, let's delve deeper into the mortgage switch. Is it worth while? Should you do it?
Why should I switch mortgage lenders?
There are three reasons that you might want to switch your mortgage to another bank. The three reasons to switch are:
- Lower interest rate
- Better pre-payment privileges
- Better terms and more favorable penalty calculations
Each of these reasons are important and I would recommend that you consider all three before making a decision to switch from your current lender.
1. Lower interest rate
The interest rate is the number one reason to switch your mortgage. If your mortgage is coming up for renewal and you can get a lower interest rate than your bank will offer, then why not choose the lower rate.
Let's look at an example and compare two mortgages with an interest rate difference of 0.20% to see the savings. Let's assume a mortgage balance of $500,000 and compare a 5 year term at 2.79% vs. 5 year term at 2.99%
|Compare Mortgages||5 Year @ 2.79%||5 Year @ 2.99%|
|Starting Mtg Balance||$500,000||$500,000|
|Principle & Interest payment||$2,312.68/mth||$2,363.66/mth|
|Mthly payment difference||-$50.98 (less)||+$50.98 (more)|
|Total difference (60 months)||-$3,058.80||+$3,058.80|
|Mtg Balance after 5 years||$425,635.01||$427,290.89|
|Mtg balance difference||-$1,655.00||$1,655.00|
As you can see and interest rate that is less than a quarter percent will provide substantial savings over 5 years. In this example, $4,714 of savings over 5 years or 0.94% of the principle mortgage balance.
I will make one caution regarding rates. Today, many lenders will offer lower rate options but those come with restrictions. Sometimes, when you choose a lenders "lower rate / basic mortgage', you are giving up some future flexibility to get a slightly lower rate.
That's why you shouldn't make a decision just based on interest rate. You must also consider and compare prepayment privileges and mortgage terms.
2. Better prepayment privileges
When you shop for a mortgage, most of the lenders will highlight their prepayment options. These options allow you to pay off the mortgage faster. You can increase the mortgage payment or you can make lump sum payments toward the mortgage.
The easiest way to pay off your mortgage faster is to make bigger payments. For payments, some lenders offer as little as 10% increases each year. Some lenders will offer up to 20% payment increases each year. Some will offer double up and some offer a combination of that.
In addition to increased payments, mortgage lenders in Canada offer a lump sum payment option. You are allowed to pay up additional cash toward the principle of your mortgage without incurring a mortgage penalty. This lump sum can range again from 10% of the original mortgage amount up to 20% of the original mortgage amount.
For the lump sum payment, some lenders allow you to make payments at any time throughout the year, in any number of payments with minimum lump sum payments of $100 each time.
Other lenders could be more restrictive. You may only be allowed to make lump sum payments on the anniversary date or on the payment date.
Not everyone takes advantage of prepayment privileges. Even if you don't use the prepayment privilege, you may be able to utilize it if you chose to pay off the mortgage early.
Some lenders will allow you to apply a lump sum prepayment prior to the full mortgage payout, then payout the mortgage after. This reduce the penalty that the lender would charge and could be a substantial savings. Other lenders don't allow this.
Find the facts and understand the consequences and options that are available to you. This will help you make a more informed decision. Next, review the terms.
3. Better terms and more favorable penalty calculation
To review the terms of the mortgage, the items you want to focus on are the following:
- Mortgage porting requirements
- Penalty calculations
Mortgage Porting Requirements
When you PORT your mortgage, you move the remaining balance, interest rate and term to your new home. You would typically PORT your mortgage if you have a really good rate, lower that what's available on the market now.
By Porting the mortgage, your bank will not charge you a penalty. You will have to re-qualify for the mortgage and if you need more money, then your lender will blend current rates with your existing rate to come up with a "blended" rate.
The factor to review when choosing a lender is the length of time allowed between the sale of your home (payout of your mortgage) and the set up of your new Ported mortgage.
Some lenders will only allow this to occur on the same date. Some lenders will allow up to 30 days between the payout of your existing mortgage and the set up of the new mortgage. Others will allow up to 90 days.
The longer a lender allows you to PORT your mortgage, the less pressure you have to have the sale and purchase dates line up. This can be especially tricky if you are purchasing a new home that is under construction.
This aspect of choosing a new mortgage is often over looked. It doesn't always come into play but it could. I believe that you should choose with your eyes open. If you are unable to match up sale and purchase dates, then you would be charged a penalty.
Let's take a look at how penalties are calculated for different lenders.
I have written a comprehensive article discussing penalties and calculations. You can read the mortgage penalty article here.
The best way to compare lenders related to their penalty calculations is to actually compare the calculation. We don't know what the interest rates will be in the future, so assume the rates remain the same as they are today and calculate based on that.
Calculation Example: You have a $500,000 mortgage. You have a choice between 2 lenders offering the same interest rate for a 5 year term.
Discount Based Calculation:
One lender calculates the penalty based on the discount provided when your mortgage is first set up. They subtract the discount from the posted rate to calculate the replacement rate. The replacement rate is then compared to the rate you have on your mortgage. (Lenders who do that include RBC, TD, BNS, CIBC, National Bank, and some others.)
Replacement Based Calculation:
The other lender calculates the penalty based on a comparison to the replacement rate (posted rate) when the mortgage contract is broken. The replacement rate is the posted rate for the remaining term compared to the rate you have for your mortgage. (Lenders who do this type of calculation would include First National, RMG, MCAP, Merix, Lendwise, ATB, and others)
This calculation is called the Interest Rate Differential. The lender will also calculate 3 months interest. The penalty charged by all the lenders is the greater of 3 months interest or the Interest Rate Differential (IRD).
Here is a table showing the typical posted and discounted interest rate for lenders who charge a penalty based on the discount provided. You would likely recognize this for the big 5 banks in Canada.
|Term||Posted Rate||Discounted Rate|
|1 year term||3.59%||3.59%|
|2 year term||3.74%||3.24%|
|3 year term||3.89%||2.99%|
|4 year term||3.94%||3.14%|
|5 year term||5.34%||2.79%|
Here is a table showing the typical posted and discounted interest rate for lenders who charge a penalty based on the posted rates they offer. This is a typical mortgage rate offer by a Monoline Mortgage lender in Canada.
|Term||Posted Rate||Discounted Rate|
|1 year term||3.99%||3.99%|
|2 year term||3.19%||3.19%|
|3 year term||3.09%||2.99%|
|4 year term||3.09%||2.99%|
|5 year term||2.89%||2.79%|
Client Example: Compare Two Lenders
For our client, they start off with a mortgage for $500,000 and receive an interest rate offer of 2.79% for a 5 year term. This is the same offer by two different lenders. The main difference between these lenders is that they offer. Let's also assume all other options are the same. Prepayment privileges are 20% + 20%. Port options are the same.
Which mortgage would you choose? Here is a summary of the mortgage when they would be first set up:
Lender Penalty Calculation
|Starting Mtg Balance||$500,000||$500,000|
|Discount From Posted Rate||2.40%||Not calculated|
After 1 years, let's assume interest rates remained the same. The client would have 4 years remaining on the mortgage. The client has sold the home (or wanted to refinance the home) and is faced with a penalty. Let's calculate the penalty for each lender.
Lender Penalty Calculation
|Balance After 1 year||$485,939.56||$485,939.56|
|4 year term posted rate||3.94%||3.09%|
|Interest Rate Difference (IRD %)||1.25%||0.00%|
|IRD $ Calculation||$24,296.98||$0.00|
|3 months interest||$3,389.43||$3,389.43|
As you can see, a lender who calculated the penalty based on the discount offered to you when your mortgage was first set up charges a substantially higher penalty. $24,296 versus $3,389. Which lender would you choose?
What if this client waited? Let's assume this client stays in their home for 2 years, then decides to sell or to refinance. There would be 3 years remaining on the mortgage contract. How would the penalties compare?
|Compare Mortgages||Discount Based
|Balance After 2 year||$471,484.09||$471,484.09|
|3 year term posted rate||3.89%||3.09%|
|Interest Rate Difference (%)||1.30%||0.00%|
|IRD $ Calculation||$18,387.88||$0.00|
|3 months interest||$1,288.60||$3,288.60|
For this example, the client would pay $18,387 penalty if he chose to pay off his mortgage early and chose the lender who calculates the penalty based on the discount offered on the mortgage when it's set up.
He would only pay a 3 months interest penalty if he chose a lender that compares the current rate with current posted rates.
That's a difference of over $15,000. Which lender would you choose?
When switching a mortgage, it's important to consider all the factors including the interest rate that's being offered.
How much does it cost to switch mortgage providers?
Depending on when you want to switch your mortgage the cost could be quite low. In some cases, lenders will cover some of those costs.
If you switch your mortgage at the end of the term, your current mortgage holder will not charge a penalty but could charge a mortgage transfer fee ranging from $200 to $500 depending on the province you life in.
The legal fees to switch your mortgage are typically covered by the lender you are moving to. There is some admin required to change the mortgage registered on the title to your home, but they don't discharge the current mortgage. They will leave the current mortgage in place and make sure it points to them instead of the past mortgage lender.
To switch your mortgage with no penalty, you must wait until the end of the term. If you switch your mortgage lender before the end of the term, then there is a penalty. I went through some example calculations in the previous section.
You may feel that it is better to switch during the middle of your term. I like to use this calculator to determine if it's worth it. I explain how to use this calculator in detail in this article called, "Is it worth it to refinance my mortgage?" please go here is you have any questions.
With this calculator, you can compare mortgages and rates. You can add the penalty to one side and compare with the other side at different rates. I like it for the flexibility and allows you to compare the numbers very quickly. If you have questions, complete your personal details in the middle and myself or a member of my team will connect with you.
When switching mortgage lenders at renewal, you might not have a penalty but there may be a couple of costs. You can include these costs when you use this calculator.
A mortgage switch doesn't usually cost too much because the new lender will typically pay the legal fees. If you were looking to refinance, then there would be legal fees. Each province charges slightly different legal fees.
Switching lenders mid term will cost more because of the mortgage penalty.
Always review all your numbers with a professional before you sign anything. Know what you are going to spend and make sure that you are moving forward financially by making this decision.
When can I switch mortgage lenders?
You can switch mortgage lenders any time. Depending on when you choose to switch you may pay more fees and penalties than if you waited.
If you switch mid term, then you will pay a penalty to you current mortgage lender unless you have an open mortgage. If you wait until the end of the term, then there will be no penalty and this is usually the least expensive time to switch lenders.
Should I switch mortgage companies before the term ends?
Switching mortgage before term ends can be advantageous to you but it depends. Know your numbers. There is a calculator, in the "How much does it cost" section of this article.
If rates have moved down by 1%, and your penalty isn't too big, you may be ahead by switching before the term ends.
I use a rule of thumb... If you can recover the penalty before the end of your term or within 18 to 24 months (which ever is earlier), then it's worth it to switch your mortgage early.
If you chose 5 year term and you were able to recover your costs within 18 months, then you will have an additional 42 months at a lower interest rate and further savings. In this case, it's worth it to switch before the term ends.
Always do the calculations.
How to switch mortgage companies
Switching mortgage companies is fairly straight forward. First, speak with a mortgage broker. I am biased as a mortgage broker. Speak with me even, but if you don't speak with me (or a member of our team), then find a mortgage broker to review your options.
If you visit a bunch or different banks yourself, you may be able to compare rates but you may not know all the questions to ask and the subtle differences between the mortgages being offered.
A mortgage broker can highlight all the different options available to you with each lender, including many of the terms and options that we discussed earlier in this article.
To switch to another bank (lender), you will be complete an application. The new lender will also want to review your documents to ensure that you qualify for the mortgage. They may have to complete an appraisal (sometimes they will pay for it when the mortgage funds, sometimes they don't)
The new lender will check your credit, check your income documents, verify that your property taxes are being paid as part of the switch process. Once you are approved, then you will receive a commitment with the rate and terms, etc.
This is when you should do the math. If you are getting better terms and a better interest rate, then switch. If you are getting a better interest rate but not such good terms, then you need to weigh your options.
You could just renew with your current bank. That's always an option.
Do you need a lawyer to renew or switch your mortgage?
No, you don't need a lawyer to switch the mortgage. The lender will often use the services of a title company to complete the switch documents at their cost. You are rarely asked to pay for the administration to switch the mortgage on your home's title. This is one of the few costs that your bank will pay.
Why should you stay with your mortgage lender?
We have talked a lot about switching your mortgage and I touched on staying with your current lender very briefly but it's important to know the difference between switching and staying.
When you switch to your new lender, you complete an application and have to qualify for the mortgage. If you stay with your current lender, you don't have to qualify. Yes, that's right. You don't have to qualify.
If your life has changed and you don't qualify to switch, you can still stay with your current lender and keep making the payments. It's important to know this.
If you recently started your own company and you haven't been paying yourself as much as you were when you applied for the mortgage, then you may not qualify to switch.
Connect with us or another mortgage broker to review your options so that you know what you can do and what works for your best interest.