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Why You Should Think Twice about a Mortgage with the Big Banks

Whether you’re a first-time homebuyer or you’re renewing your mortgage, it’s important to shop the market for the best mortgage rate. The days of most homeowners strolling down to their local bank branch to obtain a mortgage may be numbered.

The share of new mortgages obtained through banks is dwindling. 42 per cent of all new mortgages in 2013 were obtained from a bank, while 40 per cent were obtained through a mortgage broker, according to CAAMP’s Annual State of the Residential Mortgage Market in Canada. In fact, overall mortgage broker share has increased from 25 per cent to 28 per cent since last year.

While a lot of homeowners are wising up to the benefit of shopping the mortgage market for the lowest rate, over half of homeowners still obtain their mortgage with a bank. When you’re obtaining a mortgage with the big banks, it’s important to find out about mortgage penalties. The big banks have some of the most costly mortgage penalties out there – you can end up paying thousands just to escape your mortgage early.

The Difference between Variable and Fixed Rate Mortgages

Although you may have purchased your home with the intention of living there until retirement, financial circumstances can change. You may have to sell your home and break your mortgage for a number of reasons, including losing your job, divorce and the death of a spouse. If you have a closed mortgage like most Canadians, you’ll most likely have to pay a mortgage penalty. The mortgage penalty is supposed to compensate the mortgage lender for the lost interest from paying off your mortgage early.

According to CAAMP, a quarter of homeowners (26 per cent) have a variable rate mortgage. With a variable rate mortgage your mortgage penalty is pretty simple: three months’ interest. The penalty with variable rate mortgages is the same across the board whether your mortgage is with a big bank or credit union.

Two-thirds (66 per cent) of Canadian homeowners have fixed rate mortgages. The mortgage penalty with a fixed rate mortgage can be very costly. Most homeowners lock-in with a 5-year fixed rate mortgage, not realizing it can end up costing them later on. With fixed rate mortgages, your mortgage penalty is the greater of three months’ interest or the Interest Rate Differential (IRD).  Here is a good summary of why a 5 year fixed may be a bad idea.

How the Posted Rate of the Big Banks Comes into Play

The posted rates can vary a lot between lenders. While you can obtain a fixed rate mortgage for as little as 2.89 per cent today, the big banks are still charging as high as 4.99 per cent – what gives? If you’re willing to do the legwork, you probably negotiate your way to a lower rate, but the inflated posted rates of the big banks can still come into play.

You may be curious why the big banks have such uncompetitive posted rates – the main reason is the IRD. When the IRD is calculated, it uses a comparison rate. While most secondary lenders like First National use the discount rate when calculating the IRD, the big banks use their inflated posted rates. This can result in mortgage penalties adding up to thousands of dollars, even if rates haven’t changed much since you obtained your mortgage. Scotiabank was recently in the news when it charged an injured soldier a mortgage penalty of $7K for escaping his mortgage early.

Conclusion

Before signing up for a mortgage with a big bank you should really think long and hard. Although the big banks may be willing to match a lower mortgage rate offered elsewhere, you could still end up paying a costly mortgage penalty in the thousands if you need to break your mortgage early. There are ways to avoid and minimize mortgage penalties (some mortgages allow you to “port” or “blend and extend” if you’re purchasing a new home), so speak with a mortgage broker if you’re considering breaking your mortgage.

Did you ask about mortgage penalties when you signed up for your mortgage? Have you ever broken your mortgage and paid a hefty mortgage penalty?

About the AuthorSean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University. You can read some of his other articles here.

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About the author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University. You can read some of his other articles here.

{ 21 comments… add one }
  • debt debs July 14, 2014, 9:13 am

    I think it depends a lot on how long you’ve been with a big bank and what your credit rating is etc. I have 3 step mortgages with a big bank at rates of 2.5%, 2.79% and 2.89%. The oldest one is from 2+ years ago. I will be starting the renewal process for that this fall. I’m hoping to get lower than the current 2.79% and I will leave my big bank if I have to. I have good sized prepayment options though, and I don’t want to lose those since I am planning to have them all paid within the next four years.

  • Goldberg July 14, 2014, 10:25 am

    Its like buying a car, a major house renovation, or any big ticket items, you should shop around rather than just head to the local guy. Makes sense.

  • Cold Truth July 14, 2014, 10:41 am

    First off, remember, whenever someone is providing you a service and you’re not paying for it, they don’t work for you. With brokers, they are ultimately working for themselves (best commission) or the lender (they actually pay them).

    If you already have a mortgage or other large assets with a vender, you have some bargaining power you could use.

    However, places like PC Financial have very good rates, and the advertised rate IS the rate. You can’t negotiate better AFAIK.

    So check out PC, then go get a mortgage broker and say, “This is what can I get in a grocery store. Go find me something better.”

    Twice my broker came back with deals worse than PC Financial (most clients don’t do their homework, isn’t that what the broker is for?). I had to spell it out for them. Then they came back with a deal through a credit union that was a slightly better deal than PC, so that’s what I took.

  • Robb Engen July 14, 2014, 10:56 am

    I think the solution is not necessarily to avoid the big banks, but to not lock yourself into a 5-year fixed rate mortgage. The penalty for breaking a variable rate mortgage is much cheaper than with a fixed rate mortgage, and 9 times out of 10, a variable rate will save you money.

    I’ve never used a broker, but I’ll shop the market myself and then negotiate with my bank to get them to match the best deal.

  • Evan July 14, 2014, 1:26 pm

    We’ve stayed with our big bank, where we do all our business, for the last 3 mortgages in a row. They’ve been within about 0.05% of the best rate a broker could do. I’ve asked them to waive banking fees, which brings it back to even. The convenience of having it all on one screen is worth something as well. We did fixed once and variable twice (P-0.95 and P-0.8).

  • Money Beagle July 14, 2014, 4:08 pm

    I’ve had four mortgages, two at each place I’ve owned (the original, and a re-fi for each), and I’ve used the same bank for all four. I know the process and know the history that fifteen years of dealing with them has been able to give, so that’s a nice thing to have.

  • @Robb Engen Great point! There’s a miss match in the Canadian real estate market. Most first-time homebuyers choose a 5-year fixed rate mortgage, yet over half of them will break their mortgage within the 5 years. With rates as low as they are, variable mortgages will save you money and you won’t have to pay a step mortgage penalty either!

  • Sampson July 15, 2014, 1:46 am

    Hold on…the title of this post is quite misleading…

    Are you suggesting not to take a mortgage from a bank even if after working with a broker to determine which product fits you best, and if they suggest one from a big bank… don’t take it?

    Brokers do not only work with alternative lenders, and in fact, even outside of the big five, many mortgage lenders are owned by big banks anyway…

    so maybe it needs to simply be rephrased as make sure to shop around, whether you use a broker or not to do this depends on your knowledge and how much time you have to look at your options. Mortgage brokers, like any broker may have more knowledge, or, they may direct you to their friends or lenders whom give them a greater cut, they aren’t always fully on the borrower’s side.

  • Sampson July 15, 2014, 1:48 am

    Actually, big banks hold over 65% of all Canadian mortgages, whether they sell the products directly, or through the broker channel.

    http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2013/06/mortgage-market-share-top-10-lenders.html

  • My Own Advisor July 15, 2014, 7:42 am

    I’m with Robb, big banks often have good deals Sean but you need to consider something other than a five-year fixed-rate mortgage. It is the product of choice for many reasons but it certainly doesn’t have to be.

    Mark

  • SST July 15, 2014, 11:16 am

    re: “Most first-time homebuyers choose a 5-year fixed rate mortgage, yet over half of them will break their mortgage within the 5 years.”

    If you know this then the Big Banks must also know this. So why aren’t they informing their perspective clients of this fact in the first place? If 5-yr fixed is such an ill-fitting product, then why is it being sold? Big Banks always do the right thing, right? ;)

  • FormerBeanCounter July 15, 2014, 4:58 pm

    +1, variable all the way! I’m almost 4 years into my 5 year term of prime – 0.6 and have no regrets.

    Also, for the love of god, don’t buy mortgage insurance.

  • A Frugal Family's Journey July 16, 2014, 2:06 am

    Thanks for sharing…we agree 100%. Our last two refinances were done through a mortgage broker! We compared rates each time and going through a mortgage broker was hands down cheaper than any rate a large bank was able to offer. The only downside is that you generally do not know who will end up servicing your loan as it will typically be packaged up and sold to one of the larger banks.

  • Dan @ Our Big Fat Wallet July 16, 2014, 4:08 pm

    I’m also with Robb. Big bank or not, the penalties are still there and definitely worth considering (and then tend to be huge with 5 year fixed rate mortgages). We went with a big bank for a mortgage because they offered a rate that any broker couldnt match, so it’s always best to shop around with banks and brokers.

  • Michael Kohn July 16, 2014, 7:08 pm

    I once hired a broker hoping for magical knowledge with banks
    At the end going to the bank personally I negotiated better terms of any proposal received by a person paid for it.

    Ps: My mortgage is fixed rates, I’ll never choose a variable ones.

  • Geoff July 17, 2014, 11:14 am

    @ SST – re “Big Banks always do the right thing, right? ;)”

    Yes, yes they do. The right thing for their shareholders. IT’S A BANK, not a charity people!

  • Jay July 25, 2014, 4:18 pm

    I have to disagree with the article’s statements regarding IRD calculation. Obviously different institutions may offer different forms of mortage contract, but my personal experience does not line up with what is described here.

    I reviewed my (big bank) mortgage documents recently, where it spells out exactly what the posted rate was at the start of the term, and what my discount was off that posted rate.

    In the event I need to break the mortgage, the IRD is determined by applying that same discount to the posted rate at the time of the break.

    Yes, this could still result in a fairly punitive IRD charge, but not nearly to the extreme that the article describes.

  • figc November 5, 2014, 2:36 pm

    I used a broker for all of my mortgages (all variable).
    I’m currently at 2.2 (P -.8)….very doubtful I could have gotten that rate myself at a big bank

  • SST November 5, 2014, 3:16 pm

    @figc – I secured the exact same rate at a big bank (RY).

  • Ed Rempel November 6, 2014, 12:38 am

    Hi Sean,

    I think the problem is not necessarily big banks, but 5-year fixed mortgages. I call them the “5-Year Fixed Mortgage Trap”. There is an article on MDJ.

    I read an article from a mortgage broker that compared 5-year fixed to five 1-year fixed since 1950. The score today is:

    1-year fixed: 61
    5-year fixed: )

    This does not guarantee that 5-year fixed won’t slightly save money sometime.However, the study shows that essentially every Canadian that has ever taken a 5-year fixed has wasted money.

    On top of 100% chance of losing money, about 1/3 pay the penalty before their 5-year mortgage comes due. And you are right about the IRD making penalties very high quite often.

    I had a client with a $31,000 penalty to get out of her 5-year fixed. However, it was worth it because we could save more than that in the remaining term by breaking the mortgage and replacing it with a short term mortgage.

    Both banks and mortgage brokers tend to recommend 5-year mortgages, because they are paid much more for them. I’ve seen disaster stories in both cases:

    – Renewal letters offering the posted rate, which takes advantage of those with little knowledge.
    – A credit union that sold a high-rate 5-year fixed and did not allow breaking it. The penalty was “make all the rest of your mortgage payments today”.
    – A guy went into a bank asking for a 2-year fixed at 2.34% with a readvanceable mortgage where 1/3 is tax deductible. The banker persuaded him to get a 5-year fixed at 2.89% conventional mortgage and mix the tax-deductible with the non-deductible.
    – People with a lot of debt being sold 5-year fixed at posted rates, taking advantage of their fear.
    – A couple that had their home listed for sale and a mortgage broker persuaded them to take a 5-year fixed.

    One disadvantage of mortgage brokers is that it is more difficult for them to absorb legal and appraisal fees.

    My advice:

    1. Shop around.
    2. Negotiate fees.
    3. If your mortgage person recommends a 5-year fixed – RUN!

    Ed

  • Robert Klein December 30, 2014, 5:06 am

    I did a blog post on how a large bank calculates their fixed rate penalty. It’s bad. I got a cease and desist order based on it. From that I had to take the banks name off of it. – http://www.robertkleinmortgagegroup.com/blog/how-royal-bank-creates-massive-profits-from-mortgage-penalties

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