Have fixed payments on a variable-rate mortgage? Here’s when you’ll really start to feel the pain of rising rates.
If you have a static payment Variable Rate Mortgage (where your payment does not change, even if the Prime Rate rises), here is a decent article about the “Trigger Rate” (This was something I also wrote about in my book The Mortgage Code).
The Trigger Rate is reached once your payment is no longer enough to cover the interest payments. All lenders treat this a little differently, and most of us have a while to go before we even reach this Trigger Rate.
Why Variable-Rate Penalties are Cheaper
Ever wonder why prepayment penalties are often so much greater with fixed-rate mortgages? Standard variable-rate penalties are only three months’ interest – roughly $800 per $100,000 borrowed, at today’s rates.
But fixed-rate mortgage penalties are usually based on the higher of three months’ interest or the interest rate differential. They can go up to $2,500 to $5,000 per $100,000 borrowed if rates are flat to trending down – depending on your lender and interest rates at the time.
“Fixed-rate mortgages are backed by investors looking for non-fluctuating returns,” says Andrew Gilmour, managing director at CMLS Financial. In other words, the investors and banks who fund fixed mortgages don’t like surprises.
When a borrower breaks their fixed-rate mortgage early, penalties help those investors recoup the return they originally planned on, “which is why the penalty increases as rates on new mortgages go lower,” he says.
“On the other hand, floating-rate mortgages are usually quoted as a spread to a floating benchmark, the prime rate for example,” he adds. That spread usually doesn’t change dramatically over the course of the mortgage term.
As a result, if you break a variable-rate mortgage early, the investor can usually reinvest at close to the return that was originally planned, “since the same benchmark would be used for a new mortgage,” Mr. Gilmour says.
What’s more, funds for floating-rate mortgages are more often supplied from a bank’s internal sources (deposits, for example), notes Albert Collu, chief executive of Marathon Mortgage Corp. “Those internal costs of funds are not nearly the same as the liability of providing a guaranteed return when securitizing and hedging a fixed-rate mortgage,” he says.
That’s why fixed-rate mortgage penalties can be drastically larger, particularly when rates are falling. And falling rates are indeed likely after our central bank gets inflation under control. At that point, hundreds of thousands of Canadians will be rushing to refinance. And many will be learning about penalties the hard way.”
If you have any questions regarding this update, please don’t hesitate to reach out to us today at firstname.lastname@example.org. We would be happy to review your current mortgage, financial goals, and future plans to help determine the best solution to fit YOUR needs.
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