If you navigate to the mortgage rates section on most of the major Canadian bank websites, you will notice there are typically two rate columns. One for ‘posted rates’ and the other devoted to ‘special offers’ (as described by RBC, for example), otherwise known as discounted mortgage rates.
The starting point of negotiation should be the latter category of rates, but many consumers are unaware of this and go in to mortgage meetings ill equipped. In fact, the more loyal to your bank you are – if, say, you have three or more products with one bank – the less of a deal you are likely to be offered. Your bank interprets your loyalty as reason to believe you are less likely to shop around, making you less price sensitive.
Further, those borrowers up for mortgage renewals are even less likely to shop around (85% renew with their existing lenders). So, resist the temptation to sign the dotted line when your bank sends you a mortgage renewal notice. It can save you a full percentage or more on your annual mortgage rate, or thousands of dollars.The Bank of Canada’s recent report on ‘Discounting in Mortgage Markets’ confirms this rationale and found that new clients received a rate discount of .10% more than existing clients, and that, on the whole, ‘loyal customers pay more’.
However, the most financially devastating aspect of the posted rates game is one you cannot foresee. If at some point during your mortgage term you need to refinance, posted rates become even more significant in calculating your refinance penalty.
Refinance penalties are typically calculated as the greater of three months interest, or, the more likely culprit, what is known as the Interest Rate Differential (IRD). The IRD is a complicated calculation, and often not a transparent one. Banks often mask how it is calculated, but it is supposed to capture the difference in the interest payable on your existing mortgage versus that payable on a replacement mortgage.
[Remember, once you refinance, you can take out a new mortgage with your existing lender or you are free to move to a different institution.]
When a lender with only one set of mortgage rates, such as ING, calculates the IRD penalty, their calculation is more straightforward, as they only have one set of rates.
When calculating the IRD penalty with a lender who uses two sets of rates, the formula becomes more complicated.
In the latter case, the bank’s IRD calculation is now based on the current posted rate, a rate which the bank has the ability to manipulate. If a lender with posted rates sees an opportunity for customers to refinance and take advantage of lower mortgage rates, the bank has the ability to increase a customer’s penalty by keeping the posted rate artificially lower on mortgages with the remaining term.
Lenders with only one set of rates, such as ING, do not have the same pricing mechanism at their disposal. Rates used in IRD calculations are the same rates offered to customers currently shopping for a mortgage. So, if ING were to suppress rates for the purpose of IRD calculations, it would have to give new customers that same, artificially low rate. Banks with posted rates, however, can manipulate two separate rates: posted rates which affect IRD penalties and discounted rates for customers currently shopping.
IF YOU WISH TO SEE SOME CALCULATIONS BEHIND THIS DISCUSSION, PLEASE READ ON.
Elisseos Iriotakis of Safebridge Financial encourages his consumers to think about IRD penalties when selecting their lender. In January 2008, one of his clients was offered identical rates through ING and TD Bank, and the customer opted for ING as the more favourable alternative considering the potential refinance implications. Elisseos is constantly monitoring arbitrage opportunities for his clients, and in August 2009, approximately two years in to a 5-year mortgage, Elisseos found an opportunity for his client to save a few thousand dollars with a lower 3-year fixed mortgage rate. Elisseos calculated the refinance penalty with ING, and determined the equivalent penalty if the client had opted for TD Bank. Let’s have a look:
The IRD with ING to break the mortgage is $3,500.
The 3-year fixed mortgage rate available to Elisseos’ client in August of 2009 was 2.89%, meaning the savings by refinancing would be broken down as follows:
Stay in existing mortgage: 3.79% x (40/12) x $350,000 = $44,216.67
Refinance: 2.89% x (40/12) x $350,000 = $33,716.67
Total savings: $44,216.67 – $33,716.67 – $3,500 (IRD penalty) = $7000
The savings by refinancing, at $7000, is substantial. Now, imagine, instead of taking advantage of an arbitrage opportunity, you had to break your mortgage forced out of circumstance. Comparing the IRD penalties of ING versus the traditional bank above, you can see the clear benefit of avoiding a lender with ‘posted rates’.