What You Can Expect When Locking in a Variable Rate
Michael Hallett • July 7, 2020
If you have a variable rate mortgage, and recent economic news has you thinking about locking into a fixed rate, here is what you can expect will happen.
Firstly, your lender will be very happy as they will now make considerably more money off you. Not only will your interest rate increase, but the cost of breaking your mortgage will increase as well.
Now, each lender has a different way of handling this process, but it's very safe to say that regardless of which lender you are with, you will end up paying more money in interest, and potentially way more money if you have to break your mortgage.
Higher Rates
Fixed rates are always higher than variable rates. If you're a variable rate mortgage holder, this is most likely the reason you went variable in the first place. The perception is that fixed rates are somewhat "safe" while variable rates are "uncertain". It is true, as the variable rate is tied to prime, it can increase (or decrease) within your term. However, there are controls in place in Canada to ensure that rates don't take a roller coaster ride. As the Bank of Canada has scheduled rate announcements, 8 times per year, and they rarely move more than 0.25% per move, it's impossible for your variable rate to double overnight.
Increased Penalty
Obviously each lender has a different way of calculating the cost to break a mortgage, with the Big Banks being absolutely the worst, but a general rule of thumb is that breaking a variable rate mortgage will cost roughly 3 months interest or roughly 0.5% of the total mortgage balance, while breaking a 5 year fixed rate mortgage will roughly cost 4% of the total mortgage balance. So on a $500k mortgage balance, the cost to break your variable rate would be roughly $2500, while the cost to break your fixed rate mortgage could be as high as $20,000, eight times more.
Reasons People Break Mortgages
Did you know that 6 out of 10 Canadians will break their current mortgage at an average of 38 months? As we've discussed, locking in your variable rate to a fixed rate will increase the cost of breaking your mortgage. Despite our best intentions, sometimes life happens, and we need flexibility.
So here is a list of potential reasons you might need to break your mortgage.
- Sale of your home (you have to move).
- Purchase of a new home.
- Access equity from your home.
- Refinance your home to pay off consumer debt.
- Refinance your home to fund a new business.
- Because you got married (you combine assets and want to live together in a new home)
- Because you got divorced. (you need to split up your assets and access the equity in your home)
- Because you (or someone close to you) got sick.
- Because you lost your job or because you got a new one.
- Because you got relocated for work.
- You want to remove someone from the title.
- You want to pay off your mortgage before the maturity date.
Essentially, locking your variable rate mortgage into a fixed rate is voluntarily paying more interest to the bank, while giving up some of the flexibility to break your mortgage.
If you would like to discuss your personal financial situation, regardless if you have a mortgage or not, I'd love to talk with you. Please contact me anytime!
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Thinking of Buying a Home? Here’s Why Getting Pre-Approved Is Key If you’re ready to buy a home but aren’t sure where to begin, the answer is simple: start with a pre-approval. It’s one of the most important first steps in your home-buying journey—and here's why. Why a Pre-Approval is Crucial Imagine walking into a restaurant, hungry and excited to order, but unsure if your credit card will cover the bill. It’s the same situation with buying a home. You can browse listings online all day, but until you know how much you can afford, you’re just window shopping. Getting pre-approved for a mortgage is like finding out the price range you can comfortably shop within before you start looking at homes with a real estate agent. It sets you up for success and saves you from wasting time on properties that might be out of reach. What Exactly is a Pre-Approval? A pre-approval isn’t a guarantee. It’s not a promise that a lender will give you a mortgage no matter what happens with your finances. It’s more like a preview of your financial health, giving you a clear idea of how much you can borrow, based on the information you provide at the time. Think of it as a roadmap. After going through the pre-approval process, you’ll have a much clearer picture of what you can afford and what you need to do to make the final approval process smoother. What Happens During the Pre-Approval Process? When you apply for a pre-approval, lenders will look at a few key areas: Your income Your credit history Your assets and liabilities The property you’re interested in This comprehensive review will uncover any potential hurdles that could prevent you from securing financing later on. The earlier you identify these challenges, the better. Potential Issues a Pre-Approval Can Reveal Even if you feel confident that your finances are in good shape, a pre-approval might uncover issues you didn’t expect: Recent job changes or probation periods An income that’s heavily commission-based or reliant on extra shifts Errors or collections on your credit report Lack of a well-established credit history Insufficient funds saved for a down payment Existing debt reducing your qualification amount Any other financial blind spots you might not be aware of By addressing these issues early, you give yourself the best chance of securing the mortgage you need. A pre-approval makes sure there are no surprises along the way. Pre-Approval vs. Pre-Qualification: What’s the Difference? It’s important to understand that a pre-approval is more than just a quick online estimate. Unlike pre-qualification—which can sometimes be based on limited information and calculations—a pre-approval involves a thorough review of your finances. This includes looking at your credit report, providing detailed documents, and having a conversation with a mortgage professional about your options. Why Get Pre-Approved Now? The best time to secure a pre-approval is as soon as possible. The process is free and carries no risk—it just gives you a clear path forward. It’s never too early to start, and by doing so, you’ll be in a much stronger position when you're ready to make an offer on your dream home. Let’s Make Your Home Buying Journey Smooth A well-planned mortgage process can make all the difference in securing your home. If you’re ready to get pre-approved or just want to chat about your options, I’d love to help. Let’s make your home-buying experience a smooth and successful one!
If you’re looking to purchase a property, although you might not think it matters too much, the source of your downpayment means a great deal to the lender. Let’s discuss the lender requirements, what your downpayment tells the lender about your financial situation, a how downpayment helps establish the mortgage loan to value. Anti-money laundering Lenders care about your downpayment source because, legally, they have to. To prevent money laundering, lenders have to document the source of the downpayment on every home purchase. Acceptable forms of downpayment are money from your resources, borrowed funds through an insured program called the FlexDown, or money you receive as a gift from an immediate family member. To prove the funds are from your resources and not laundered money from the proceeds of crime, you’ll be required to provide bank statements showing the money has been in your account for at least 90 days or that you’ve accumulated the funds through payroll deposits or other acceptable means. Now, if you’re borrowing all or part of your downpayment, you’ll need to include the costs of carrying the payments on the borrowed downpayment in your debt service ratios. If you’re the recipient of a gift from a direct family member, you’ll need to provide a signed gift letter indicating that the funds are a true gift and have no schedule for repayment. From there, you’ll need to show the money deposit into your account. Financial suitability Lenders care about the source of the downpayment because it is an indicator that you are financially able to purchase the property. Showing the lender that your downpayment is coming from your resources is the best. This demonstrates that you have positive cash flow and that you’re able to save money and manage your finances in a way that indicates you’ll most likely make your mortgage payments on time. If your downpayment is borrowed or from a gift, there’s a chance that they’ll want to scrutinize the rest of your application more closely. The bigger your downpayment, the better, well, as far as the lender is concerned. The way they see it, there is a direct correlation between how much money you have as equity to the likelihood you will or won’t default on their mortgage. Essentially, the more equity you have, the less likely you will walk away from the mortgage, which lessens their risk. Downpayment establishes the loan to value (LTV) Thirdly, your downpayment establishes the loan to value ratio. The loan to value ratio or LTV is the percentage of the property’s value compared to the mortgage amount. In Canada, a lender cannot lend more than 95% of a property’s value. So, if you’re buying a home for $400k, the lender can lend $380k, and you’re responsible for coming up with 5%, $ 20k in this situation. But you might be asking yourself, how does the source of the downpayment impact LTV? Great question, and to answer this, we have to look at how to establish property value. Simply put, something is worth what someone is willing to pay for it and what someone is willing to sell it for. Of course, within reason, having no external factors coming into play. When dealing with real estate, an appraisal of the property will include comparisons of what other people have agreed to pay for similar properties in the past. You’ll often hear of situations where buyers and sellers try to inflate the sale price to help finalize the transaction artificially. Any scenario where the buyer isn’t coming up with all of the money for the downpayment, independent of the seller, impacts the LTV. All details of a real estate transaction purchase and sale have to be disclosed to the lender. If there’s any money transferring behind the scenes, this impacts the LTV, and the lender won’t proceed with financing. Non-disclosure to the lender is mortgage fraud. So there you have it; hopefully, this provides context to why lenders ask for documents to prove the source of your downpayment. If you’d like to talk about mortgage financing, please connect anytime; it would be a pleasure to work with you.
