Porting vs. new mortgage - The Mortgage Gal

Most people sign a five-year term when they buy a home.

You have the option of choosing either a fixed or a variable rate for your mortgage. Many opt to take a fixed rate for those five years.

People tend to choose a fixed rate because of the security of knowing what their mortgage payment will be regardless of what interest rates do during those five years.

The interest rate on a variable rate mortgage will be adjusted if prime rate changes. Lenders may handle this differently.

In some cases, your payment will be adjusted to keep your mortgage on track.

Others do not change the payments, so if interest rates rise, more of your payment goes to interest and less to principal. If interest rates drop, more of your payment goes to principal and less to interest.

Why would you choose a variable rate mortgage?

Historically, variable rate mortgages have out-performed fixed rate mortgages.

If you chose a variable rate mortgage, during the last 25 years, you would have paid off more of your mortgage than if you had chosen a fixed rate mortgage at each renewal.

In the past, variable rate mortgages were more attractive as they were priced significantly lower than fixed rate mortgages. Variable rate mortgages are priced as a factor below prime rate.

If you chose a variable rate mortgage, your documents would be worded something like this:

“The interest rate for each month shall be Lender X’s prime rate in effect on the first day of each month less .75%. Lender X’s prime rate at the date of this commitment is 2.45%. The principal and interest payment set out in this document is based on this prime rate. When the prime rate changes the principal and interest payment will be adjusted accordingly.” 

Variable rate mortgages work brilliantly in times of decreasing interest rates but can cause clients stress in times of rising interest rates.

So back to the question of why you would choose a variable rate mortgage.

Perhaps the most important reason I discuss with my clients is that should you choose to break your mortgage contract early, lenders can only charge three month’s interest as a penalty.

I worked with an online mortgage pre-payment calculator for one of Canada’s chartered banks. Assuming a current balance of $350,000, a fixed interest rate on the mortgage of 2.84%, and three years remaining in the mortgage term the penalty to pay this mortgage off early would be $20,287.

Same bank, same effective interest rate, same balance, same time remaining in the term but a variable rate mortgage and the penalty to break the mortgage early would be $2,560.

In my previous column, I talked about how not all lenders are created equal when it comes to calculating penalties for fixed rate mortgages.

When I discuss rate options with clients, despite the potentially higher penalty down the road should they choose to break the mortgage early, many clients opt for the certainty of a fixed rate mortgage.

Last week, I had conversations with several clients who are selling one home and buying another mid-way through their mortgage terms.

One client is in a variable rate mortgage and the others are in fixed rate mortgages.

The clients in fixed rate mortgages all thought they would choose to pay a penalty and take a new rate on their new mortgage until they saw what their penalties would be.

In all three cases, I ran comparisons to show them what the interest cost would be both ways (paying a penalty and taking a new rate versus taking a blended rate for the remainder of their current term).

For the fixed-rate clients, it made financial sense to port their current mortgage from their current homes to their new homes rather than paying a penalty to take advantage of today’s low rates.

For the variable rate client to port his mortgage, he had to port the exact same dollar amount and on the exact same date in order to keep his current variable rate.

In his case, this worked.

It is important to understand how your lender calculates early pre-payment penalties, and what the policies are if you want to port your mortgage sometime down the road.

If you choose a no-frills, low-rate mortgage option or a cash-back mortgage, you might be unpleasantly surprised down the road if life changes and you need to break your mortgage contract.

When you are sitting down with your mortgage professional, it is important to consider what potentially change in your life over the next five years.

Is this a starter home for you and you will most likely be starting a family and looking for a bigger home?

Are you on a career path that may include a move to another city?

Answers to these questions may help guide your decision regarding choosing a fixed versus variable rate mortgage.

This rate decision will play into whether you break your mortgage and choose a new rate or choose to port your mortgage to a new property should you sell your current home down the road.