How IRD can change and Penalties get bigger

Do you know how your penalty is calculated?

There was a client who was quoted a penalty of about $6,370 to break her $280,000 mortgage a month ago, yet today, her penalty has ballooned to over $12,000.

How did this happen in the span of a month?

On both penalty quotes, the client is being charged the interest rate differential: the interest lost to the lender for the remainder of the term.

The IRD is based on several factors: the difference between your rate and the rate at which the lender could re-lend the money (the spread), the amount being prepaid, and the time remaining.

Here's how it's calculated:

IRD = spread x balance x # of months left to end of term/12

When she first called the bank to get a penalty quote, she had 42 months left which is closest to a 4 year term. At the time, the bank's posted 4 year rate was 4.64%  & the penalty was calculated as follows:

Client's rate: 3.64%
4 year rate: 4.64%
Client negotiated a GREAT discount of 1.65% when she got the mortgage 18 months ago ( now she's going to pay for it).

You'd think the spread would be the difference between would be the difference between 3.64% and 4.64% (now the bank can EARN an extra 1% by getting the money back early), but, THIS bank takes into account the discount of 1.65% negotiated by the client. They would theoretically lend the funds out based on a rate of only 2.99% "passing along" the 1.65% discount.

spread = 3.64% - 2.99% = 0.65%.

IRD = 0.65% x  $280,000 x 42/12 = $6,370

Easy math, but how does that become over $12,000 a month later.

The spread is based on the rate closest to the remaining term. With only 41 months remaining, the bank now looks at their 3 year rate which is 3.95%.

Client's rate: 3.64%
3 year rate: 3.95%
Don't forget the discount of 1.65%
spread = 3.64% less (3.95%-1.65%) = 1.34%

IRD = 1.34% x $280,000 x 41/12 = $12,819

The additional month that has passed has resulted in a penalty that is almost $6,500 higher than quoted a month ago.

How the IRD is calculated varies between one lender and another.

As a mortgage agent I can help you understand these risks and steer you to lenders who are less "calculating" in how they punish their clients.

Part 2 On paying down your Mortgage Faster

If you really want to make a dent, then aside from simply increasing your regular mortgage payment you can use your lump sum allowance. 

This is for people who are really serious about getting their mortgage down.  If you budget your life and know your expenses and savings goals, or you just know that you have some extra money at the end of the month, or year, then you can opt to put a little more on the mortgage without upsetting your monthly cash-flow. 

This, like any other form of savings takes discipline, but unlike savings it is not as easy to take it out again so it is a much bigger commitment.  The impact can be huge. 

In the last piece I showed you how increasing your regular payments had the combined effect of lowering the balance, reducing the total interest cost and reducing the time you actually have a mortgage.  While this is not great for my business it probably will be great for your future.  Even if your current payment is as low at 1,000/month, think about what that extra thousand can do for you.

The trick for a lot of people though is foregoing what they want today for the future, and in fairness, living life is important so I am not advocating being house poor and not enjoying life, I am suggesting moderation because the debt figures suggest that too many of us are leveraging too far the other way.

Look, if Canada's richest man, when he was alive, could pack a lunch to take to work, then you have to question how someone struggling to pull it all together can justify a regular trip to a fancy coffee place.

So, consider even taking a few lunches to work and putting the savings on your mortgage, topping up your RRSP, or RESP or whatever form of savings make sense to you, every dollar counts. Or put a little on each.

Personally, as you know I hate debt, but of all debts I do understand and appreciate mortgages, not just because I now help people get them, but because they make owning a home possible for so many. 

Next piece is on why I like property.

Part 1 on Paying Mortgage down faster

  Part 1 shows how simply increasing you regular mortgage can make a difference

Why pay it down faster when rates are so cheap?  Isn’t this the time to reduce my payments and spend on other things and enjoy myself a little?

Well yes, it is certainly a great time to free up some cash to do enjoy yourself or top up the RRSP, TFSA or other investment accounts.  You may make more money there if you, or your investment person, is good at watching the markets and making the right calls.  In fact, you could make a great deal of money, but this article is more for the people who might need a little more cash later and are not as confident about the markets, or whose job or income security is not as certain in the future, or who might have heavily leveraged themselves in this low interest rate market to get the house they want.

Paying debt off now is easier because interest rates are lower and at the very least paying down debt is a reasonable form of diversification.

Think about it in this way.  The average borrowing cost for a 5 year mortgage from 1986-2011 was been 8.04%, from 2000 to 2011 it was 6.05%.  Today you might be lucky enough to be locked in at 2.99%.  What would an increase of 3% to 5% do to your ability to pay?

Double-digit mortgages (10% +) ran from the end of 1973 until November 1991 with a couple of months in 1992, 1994 and 1995 also tipping the scale just to add to the fun.  I think we can all safely say we are glad not to be there.

Assuming a mortgage of $250,000, what do the payments look like for a 25-year amortization and without going all that high?  Let’s look at the impact.

                                     2.99%                     6.05%                   Difference              Diff. Annual

Monthly –                   1,181.83                   1,606.95                     435.12                    5,221.44

Semi Monthly   -         590.92                       803.48                      212.56                    5,101.44

Bi-Weekly -                  545.46                       741.67                       196.21                   5,101.46

Accelerated

Bi-weekly -                   590.92                       803.48                       212.56                   5,526.56

Weekly -                        272.73                        370.84                      98.11                      5,101.72

Accelerated

Weekly -                        295.46                        401.74                      106.28                    5,526.56

$5,000 per year can go a long way for most people and while your mortgage will not be as high when you go to renew, if the rates are higher you will still feel the effect.

In this scenario at 2.99%

At the end of the 5 years, assuming monthly minimum payments and no prepayments, your balance would be 213,645.52. 

If at the end of that term rates have gone to 6.05%, then in order to stay on track to pay down your mortgage in the 20 remaining years your payments would jump to $1,527.56.  That is a pretty big jump for a lot of people.

If you make your payments monthly, on the 2.99% rate, but pay them as if the rate were 4.5%, $1,383.68, then at the end of the first 5 years you would see some great improvements

1. the balance would only be $200,605.93, so at renewal you are less exposed
2. you would be 5 years closer to paying off the mortgage
3. and for those benefits you still would have paid $928.59 less in interest payments meaning more has gone to principal

With that new balance and a rate of 6.05% and 15 years remaining on the mortgage your payments would jump to $1,690.13, still a big jump, but $128.67 less than if you had been making the minimum payments at 2.99% and you are still 5 years closer to being mortgage free.

If you are thinking about retirement or have kids with university or college plans, this might free up some cash just when you need it.

Wants vs. Needs when buying - my story

I think one of the toughest parts of buying a home for me was coming to terms with all the wants versus the needs and which took precedence.

Needs - 

• A home in a good school district for my soon to arrive son (some years ago)
• Ideally not too far from my parents who would help with babysitting and who often needed my help on some things.
• Affordable, both in operating costs and a mortgage that would not cause excessive strain.

Wants -

• Biggish back yard
• Driveway (optimistic) 
• Detached
• Snazzy and done up

When it came to the time to put the offer in I was in a market similar to this, bidding wars were the norm and prices were going up weekly.  I soon realized that the needs outweighed the wants.  The most important, as a new mom with all the new expenses that entailed, was affordability and in the areas I wanted that was fast disappearing, so I "overpaid" and won the bid on the third house I went after.  It had none of the things I "wanted," but it was bright, some were very dark, it was in decent shape and as my father said at the time, how much did you want to clean anyway (inside and out).  Truer words as toys find themselves everywhere...

While many people out there are at various levels of the economic spectrum I think similar tales can be told everywhere.  The trick is identifying what is really a need vs. a want and where are we willing to compromise.  In the end, I am in a great area and a school that has been incredible and while I might have "over paid" several years ago the value to me in terms of both the value of the home itself and the life I have in the area makes it look like small change now.  

Helping people find the right deal is what I do with mortgages so that when my clients go out to find the right fit for them in term of homes, they are ready to move when the perfect home comes along.. 

The Economy and Rates

Welcome to 2012.  We have had a couple of weeks to get used to the New Year and we have gone from spring to real winter in a matter of hours and back.  I am sure we are all back to getting our normal routines in order and hopefully tackling new challenges.

The news from the Bank of Canada is not a huge surprise as rates stay the same and the Prime rate remains at 3%.

I am sure everyone has heard about the deals in the news and while some of them come with some real hitches I cannot argue with the rates.  The interesting thing is that these days the range of rates for mortgage terms of 1 - 5 years and even the variable is 0.44%, so while you might be edging out a slightly better deal at one lender or another on the rate, please remember the fine print also counts for something when it comes to your options down the road.

The really interesting deal right now is a 10 year mortgage at 3.89%.  Talk about stability.  If you are planning to stay put and worried that increased rates in 5 years might make things a bit uncertain then this is the term for you.  Honestly, if you look at historic rates this is an unheard of opportunity.  While it may not be for everyone it is a great option for many.  Here is what Rob Carrick from the Globe had to say.

"Let's get back to the housing market for a moment. The biggest support for prices right now are the low mortgage rates we've been talking about here. When rates rise, that support crumbles. Things could get ugly.

Why consider buying now? Because you can borrow money at 3.99 per cent or a bit less for 10 years. It's like freezing time at the exact best moment ever to finance the purchase of a house. If the price of your home declines, it's bound to be on the rise again a decade from now. Meanwhile, you'd have the chance to put a decade's worth of salary increases to work in ramping up your payments and making periodic lump-sum payments."

So consider your plans and your options.  Note that after 5 years the penalty to break a mortgage is only 3 months interest - just like a variable rate loan.

it would seem the banks may have done the heavy lifting for now on the economy so the rates are holding for now.  Global stability is still not on the horizon and $100/ barrel oil is really going to drain disposable income.

While Canada still seems to be strong, largely related to our resource and financial services sectors.  However our labour market is not doing very much and is pretty flat and the housing market in some areas is showing signs of cooling.  The US economy is looking a bit better but everyone is affected by the events in Europe and even China is slowing. 

In Europe, Germany is seen to be weakening and doubts are being raised about its ability to support the weaker members of the EU, or at least the effects on Germany may be more than expected.  Whatever happens in Europe, they seem to be taking it as slowly as possible.  My main hope is that whatever they decide to do that they keep their minds open to new ideas, since old ones seem to have created the problem and recession and more banks collapsing is still possible.

The effect in Canada though of the low rates may reboot the housing sector a bit, and despite the December over spending many seem to be getting their debts under control.

Fraud - It can affect anyone

I recently did a short course on fraud.  It is part of my continuing education to keep me on top of my game in this business. 

It was quite interesting and borderline shocking.  Canadians and others have long looked at "white collar" crime as less important and of less concern and as a result there are not the policing resources, the sentencing levels or the statistics to help us truly deal with this problem.  One of the interesting facts that came out was that the cost of all forms of fraud in Canada is estimated to be about the same as the drug problem, or between $12 and 38 Billion per year.

To me the worst part of it is that it often seriously hurts people who otherwise stay out of trouble, they are not thugs or drug addicts and yet they can loose their life savings with one bad judgment call. 

The people that perpetrate the frauds are part of organized crime for the most part, and they often use the proceeds of the fraud to help fund their guns and drugs etc..

In 2008 there were 1.7 million victims of identity fraud in Canada and it can cost people a lot of time and money to sort it out and clean up the damage.

While the full breakdown of statistics is not available in Canada the estimated mortgage fraud is about $200 million per year and while the course is not going to tell me how it is done, for obvious reasons, we do know aspects of it.  I have heard tales of people faking powers of attorney and acting for seniors and selling their house from under them.  I know about the "straw man" approach where someone fronts for someone else.  There are tales of bankers, lawyers and yes, mortgage agents all playing a role at one time or another so we all need to be vigilant and make sure we protect our information.

Having title insurance is one way to help protect your home, and you can clear the cache on your computer, keeping your virus protection up to date, shredding documents with key information on them before sending them to recycling, and not looking for easy money over the internet, the mail, the email or over the phone.  The people who run these frauds know which type of fraud is most likely to succeed with which demographic and though we all think it cannot happen to us, the facts show that every age group, gender and education level has been hit at one time or another.


Be careful, do your homework and when in doubt check references or just steer clear.

Stay safe and fraud free and if you suspect you have been had or are being had, do not be embarrassed call the police or RCMP and be part of the solution.

Multi Part Mortgages

One of the things I see is people with a mortgage at a bank and it sits in multiple pieces, different amounts at different rates, maturing over the next 1 - 5 years.  In a recent case I think they had 5 or 6 components.  There was the ever present Line of Credit (LOC) and then a variable and 4 fixed rates.  Sort of cool in the sense that it diversifies your debts over time and you are not subject to renegotiating it all at the same time when rates are high.  Conversely, you are not able to renegotiate when rates are at record lows.
This client was definitely in need of an overhaul and there was tons of room for savings even with the penalty factored in.  Without doing the work it is hard to know if making the change is a good choice or not.  I would never advocate change that is not beneficial, but I am a big advocate for checking out your options.
If you are not into absorbing any sort of penalty regardless of the savings, then at least make an effort to renew each segment so that it next come due at about the same time as other segments and eventually the goal would be to have them all on the same schedule.
This helps in 2 way

1. You are renewing at shorter terms which are often cheaper and if you maintain the same payment level you are paying the debt down faster
2. Eventually everything comes due at the same time and you can now stand on a stronger footing with your bank when negotiating rates, because the penalties are no longer holding you back from leaving and getting a better deal elsewhere.

If you could save $20,000 dollars over the next 5 years would it be worth sitting down for an evening and doing the math?  Or call me and see if I can help you find options that suit you better.