by Multi-Prêts Mortgages
What you’ll learn
If you follow the financial headlines, you’re likely aware that the Bank of Canada made a rare move by cutting interest rates twice in March. On March 4, 2020, it lowered its policy rate from 1.75 percent to 1.25 percent; less than two weeks later, the rate was dropped by another half percentage point to 0.75 percent. While the successive rate cuts are intended to help the Canadian economy, they can also benefit you if you have a mortgage.
All financial institutions across the country keep a close eye on the Bank of Canada’s policy rate, because it directly affects their own prime rate. Prime rate is what banks use to set the rates on many of their loans, including personal loans, lines of credit, and variable rate mortgages.
A few days after the Bank of Canada’s first rate cut, many lenders followed suit by lowering their prime rate by 0.5 percent. A number of banks dropped their prime rate from 3.95 percent to 3.45 percent, and they may decide to reduce it further in light of the second policy rate cut.
If you have a variable rate mortgage, you’ve likely already seen the benefits of the recent rate drops. The interest rate for this type of mortgage is generally 0.5 to 1 percent below the prime rate.
In practical terms, lower interest rates mean lower monthly payments. For example, if you’ve taken out a variable rate mortgage of $200,000 for your condo, amortized over 25 years, a 1 percent drop in your interest rate will decrease your payments by about $100 per month. Over the course of a year, you’ll save a cool $1,200. Your annual savings would be even greater if you had a higher mortgage: $2,400 for a $400,000 mortgage and $3,600 for a $600,000 mortgage.
For shorter amortization periods, however, the savings are more modest. If you have a 5-, 10-, or 15-year mortgage, your monthly savings may only be in the double digits.
The reason is simple. When you make a payment on your mortgage, part of it goes towards interest and part of it goes towards the principal repayment. The proportion of interest is higher for mortgages with a long amortization period (20 or 25 years), and it gradually decreases with shorter-term mortgages. Say you have a $250,000 mortgage amortized over 25 years at a rate of 2.59 percent. You’ll pay $618.24 in principal and $558.16 in interest on your first payment. On your 100th payment, you’ll pay $764.46 in principal and $411.94 in interest. On your last payment, you’ll pay only $2.52 in interest and the rest in principal.
If you have a fixed rate mortgage, your monthly payments have stayed the same. That’s because your interest rate will only be adjusted when you renew your mortgage. However, under the current circumstances, it may be wise not to wait until your next renewal.
Whereas variable rates depend on the policy rate, fixed rates are influenced by the bond market. Like the policy rate, the bond market has declined significantly in recent months.
For the past few weeks we have been observing great volatility in rates. This could lead to great savings opportunities in the long term. This is potentially a good time for you to evaluate whether it is advantageous to renew your current mortgage immediately in order to save on your interest costs. This may be particularly the case if you took out your loan about a year and a half ago, since at that time many mortgages had an interest rate higher than 3.4%.
If you decide to change financial institutions to pay less interest, you’ll owe your current lender a prepayment penalty.
The penalty is usually equivalent to either three months’ interest on your current mortgage or the interest rate differential (the difference between the interest rate on your loan and the rate currently in effect). Financial institutions choose the higher of the two amounts.
Depending on your situation, you may need to pay a few thousand dollars to break your contract with your current lender. However, in the long run, you could still save money by paying less interest with your new loan.
Our brokers have access to the lowest rates and will help you get the best possible terms for your mortgage. They can also help you calculate your mortgage penalty if you’re not sure how.
As always, we provide the option of meeting with our brokers remotely, from the comfort of your own home, rather than in person at one of our branches. All you have to do is email your documents to your broker. Protecting your personal information is important to us; rest assured that your file will be handled using secure links and with the utmost discretion and professionalism.
Who knows? A simple phone call could save you hundreds of dollars a year!