We have found it often worthwhile to break a mortgage for a lower rate, especially now. Today, we are often finding that savings in year 1 are as much as the entire penalty.

We are big believers in always staying short term (1-year fixed) or variable, and have been recommending 1-year fixed mortgages now. This is what produces a lot of the savings. In addition to the lower rate, you can save more by converting to a 1-year fixed at the same time.

Today, we are running into a lot of people with mortgages at 4-5%, often with several years left. When we convert them to a 1-year fixed at 2.4%, the savings are 2% or more per year. This is a lot more than the penalty in almost all cases, even when there is a significant penalty.

By sticking with 1-year or variable mortgages, our clients have been getting rates between 4-5% for almost all of the last 15 years. To now be able to get 2.4% is a great savings, even if it is only for one year.

Ed

My experience has been that it has never been in my best interests to break a mortgage for a lower rate because the penalties outweighed the potential benefits.

It might be worthwhile for a bank to give you a break on a portion of the fees if you were moving from a short term mortgage to a long term one, especially if the short term was open and the long term was closed.

I think it is safe to say that if the bank is willing to do it, then it is in terms more likely better for the bank than it is for you.

Thanks for that. I just checked Canadian Tire’s answer to Manulife’s M1 and NatBank’s All-in-one and their variable portion interest rate is 3.25% as well.

I’m not sure how flexible the readvanceable mortgage lenders such as BMO are, but their posted rate for a 3 year open is 3.75% and a 5 year closed is 3.05%. That means this is the highest that they would go and you might be able to do better. I can’t see that the HELOC portion would be lower than this. When I signed up last year in the summer, we received HELOC at Prime when the mortgages were P – 0.75.

The HELOCs I looked into all offer Prime +1%, so the M1 offers no advantages (unless Manulife plans to not increase their prime rate in accordance to BofC rate movements).

That depends on WHEN you entered into your variable mortgage. I predict it won’t be until late 2011 at the very earliest before my P-0.75% mortgage reaches 4% at which point I should be mortgage free (but not HELOC free).

For those getting into 2.75% now, I think there are still a good 2 years before rates creep up to 4%.

Jobs are still being lost – the pace of those losses is starting to decline (or is it that people are falling off the unemployment rolls because they’ve been on them so long?). Just last week, our company chopped 5% of staff for the 2nd time in just over a year.

The unanswered question is: How long will variable mortgages remain below some of the locked-in options?

DAvid

Great points. I didn’t see anything that is attributed to the M1 that I couldn’t do with a typical readvanceable mortgage.

Even if I put thousands down against my mortgage temporarily and then withdraw it from my HELOC, my current rate of HELOC at 2.5% is still 0.75% lower than the M1.

Now, according to Sampson above, someone trying to get a mortgage today would not realise this interest rate benefit over the M1 as Manulife actually is cheaper for new borrowers.

As I was fortunate to renew my mortgage just 3 months before this unusual situation reared its head, I am better off in my current position.

The M1 could actually be better for new borrowers if they have a high ratio of HELOC borrowing vs. mortgage balance. (I’m assuming that if you mortgages are being offered as low as P+0.5 then the HELOC portion is P+1.25 which would be 0.25 higher than M1’s reported 3.25% rate.

In the first year of a $200,000 mortgage at 3.25 % with a 20 year amortization, you would reduce your principal by $13,935 by adding the $550 per month to it.

Same mortgage at 1.5% reduces principal by $15,290. The $1355 is the additional annual interest cost paid to Manulife for the privilege of using their product. The same $550 will handily reduce ANY mortgage, but would likely be far better left invested to build the portfolio..

Daniel also said: “I still believe that the M1 offers significant benefits (rates being equal) in several cases including:”
Rates usually aren’t equal, but…..

1) Those who need to consolidate debt (if debt is your thing).
Could be done with any HELOC, and needs the same diligence with all, so as not to increase your debt.

2) People with high monthly cash flow.
If you mean people with a highly variable cash flow, or if they can manage a HUGE sweep account in the thousands or tens of thousands of dollars, then yes. Large amounts of money held in the account for short periods could reduce your costs. a special benefit if it were someone else’s money you could use for a short time.

3) People with substantial short-term savings (e.g. for myself, I pay income tax in installments, so I like having all my tax money paying down my M1 until the last possible moment when CRA kicks me in the face :P).
You could put all your tax for the first quarter against your (cheaper) mortgage then pay the taxes out of HELOC at prime. Pay down the HELOC as quickly as possible, to reduce interest costs. Continue to use the HELOC for short term borrowing to pay your taxes. The money is still available in your mortgage should you need it.

4) Convenience – I love not having to deal with a ‘fixed’ mortgage payment – I like the straight up interest payment.
Yes, there are few options that are more convenient, but it comes at a price. Each time you make an interest-only payment, you lose the benefit or interest reduction as you did not reduce your principal, so you pay the same interest amount the following month..

5) Still have to take into account the fact that for any short-term or even long-term savings – having the cash deposited into M1 does pay down the principal owing, which directly results in lower interest costs.
Long term savings could be placed against the mortgage & retrieved, while short term savings could be managed in a HELOC as described above for taxes. There would be some manipulation to do this.

For instance, my paycheque was deposited today. I took 4 or 5 minutes to log into my banking site, check the upcoming bill payments for the next two weeks (about $300), and transferred the difference to my savings. If, instead, I was reducing my mortgage, the 5 minutes, twice a month to save $300 monthly in the early period of a mortgage (see post 25) is a pretty good return for 10 minutes of effort.

Lowest interest rate is the best choice.

DAvid

I’m just going to concede the point, that all other things being equal, the lower rate is better. That concession in place, I still believe that the M1 offers significant benefits (rates being equal) in several cases including:

1) Those who need to consolidate debt (if debt is your thing).
2) People with high monthly cash flow.
3) People with substantial short-term savings (e.g. for myself, I pay income tax in installments, so I like having all my tax money paying down my M1 until the last possible moment when CRA kicks me in the face :P).
4) Convenience – I love not having to deal with a ‘fixed’ mortgage payment – I like the straight up interest payment.
5) Still have to take into account the fact that for any short-term or even long-term savings – having the cash deposited into M1 does pay down the principal owing, which directly results in lower interest costs. I know that how much this actually saves a person is going to vary wildly based on personal circumstance, which is again why people need to look at their own situation to decide what’s best for them. I’m also aware that if you have a HELOC style mortgage you can pretty much do the same thing. I just happen to use M1.

Happy Friday.

HSBC is offering VR mortgages at 2.75% now – Prime + 0.5%, RBC offered me Prime + 0.8%.

My take of the M1 is that it COULD work if the mortgagee does not get tempted by the access to the loan. However, if you are that disciplined, you might as well just get a lower rate on a traditional mortgage, and pump all cash against it. The limited prepayment amounts still allow most closed mortgages to be paid off in 5 years – I’d hazard to guess the average time to pay of an M1 is longer than that.

I’m not sure which scenarios where a lower rate wouldn’t be better – perhaps you could provide some so I can wrap my head around that.

It is fallacy to think paying down your M1 by $550/month might not be worse than paying down a 1.5% traditional mortgage. The reason why the interest benefits would be larger on the M1 is because… it costs more to service!

It would be almost like saying that if I got a 10% discount on a $20,000 car that I’m worse off than getting 10% discount on a $100,000 car – yes, I ’saved’ $10k vs. $2k but the end cost is $90k vs. $18k.

In defense of the M1, I think right now the M1 might be offered at a variable rate that is lower than a traditional variable rate mortgage because I’ve heard of P+1 as pretty common. So, at this point in time it might actually be a better choice if the best you can get is a 3.5% variable mortgage.

I agree that I’d take a 1.5% over a 3.25% rate, and M1 definitely can’t compare to all traditional mortgages (1.5% is a great rate) – and the M1 calculator dilly-o will tell you as much if you punch in numbers that aren’t going to end up saving you any money.

Readiline / Merix / other HELOC stuff can definitely be great products when the rate is right. And M1 is definitely not a good product for those prone to overspending. I still think that for people with high cash flow, M1 can be better than a lower rate traditional mortgage – everyone has to do their own DD to figure out what’s best for their particular situation.

DAvid – I agree with you that the rate difference between 1.5 and 3.25 is significant, but the lower rate isn’t -always- better (although it seems to be in this case). On the flip-side, my Smith portfolio is churning out about $550/month which is smacking down my principal nicely. Would it still work out better applying that $550 against a 1.5% traditional mortgage instead of a 3.25% M1? Could be, but I don’t have the brainpower left to do the math on that.

Yes, I’m enjoying the Kool-Aid, thanks. :)

I agree if you can pay for the penalty up front – you are likely better off applying it directly as a lump sum payment – this is only because of the newer IRD calculation. But each institution is different. With my lender, going through the IRD estimate calculation on our contract – we estimated $19k penalties, but when we actually contacted the lender to get the real amount – it was roughly $7k.

Of course there are other reasons, aside from paying off the mortgage sooner to get a lower rate such as better cash flow and protection against inflation.

The $300 per month interest differential on a $200,000 mortgage between 3.25%, and 1.5% cannot be recouped by putting every penny of your income against the mortgage, unless you chose a very, very, very, long amortization period.

So, as always, other things being equal, the lowest interest rate is the best!

Hope you’re enjoying the Kool-aid.

DAvid

Or, applying that penalty to your current mortgage balance as a prepayment and then comparing it to breaking the mortgage. I’d bet that this option comes out on top 9 times out of 10.

If I compared your M1 product with my BMO Readiline mortgage, you would see that my rate is much lower than yours – 1.5% since it is variable at P – 0.75%.

If I took the same $10,000 that was stuck in a “high” interest savings account (these days, 1.5% probably is high) and applied it to my mortgage I would save a lot less than you did because my interest rate is a lot lower.

By your reasoning, the M1 is better because its higher interest rate can ’save’ you more money.

Does that sound right to you?

You would still have -$190,000 at 3.25% while I would have a mortgage rate at 1.5%. If M1 came to you and said, no strings attached, we can reduce your rate to 1.5% from 3.25% would you say no?

I agree that having the money sit in a savings account generating 1.5% before tax is not as efficient as applying it to non-deductible debt at 3.25%. But, I don’t agree that the M1 can achieve any significant savings over a traditional mortgage unless the mortgagee’s behaviour is significantly different – at which point there is risk that the freedom of money in an M1 could lead to overspending.

Thanks for a very informative post. I’m on a 6.2% (ouch!) fix until October this year. After that my mortgage will revert (based on vurrent base rate of 0.5%) to 2.3%!! I can’t wait for that day, and I’m hoping that interest rates haven’t gone up too much by then.

Unfortunately not possible to break the contract because there is a 12,000 penalty.