The impact of the central bank's interest rate cut! Canadian homeowners face a surge in early termination of contracts, wary of high breach penalties
This week, the Bank of Canada has significantly reduced interest rates, which may make some Canadian homeowners struggling with expensive mortgages fantasize about more affordable rates. Pineapple Mortgage CEO Shubha Dasgupta pointed out that as lower interest rates emerge in the market, it is expected that more and more Canadians will plan to terminate their mortgages before they expire in order to obtain lower interest rates. However, early termination of the contract may result in high fines.
What does a mortgage default mean?
Terminating a mortgage loan contract is essentially withdrawing from the contract before the lender expires - for example, shortening the five-year mortgage loan term after two years.
Victor Tran, a mortgage and real estate expert at Rates.ca, stated that the most common default scenario is selling a property.
Another typical scenario is refinancing arrangements, where the homeowner may wish to withdraw the net value of the property already paid or interrupt the current term to take advantage of lower market interest rates.
Interruption of mortgage loans may also occur due to more personal circumstances, such as the end of a marriage, where one or both parties to the mortgage wish to cancel property ownership or sell the house to start over.
Tran gave an example: a homeowner signed a five-year fixed rate loan contract with an interest rate of 6.25%, but decided to terminate the contract after two years to enjoy the new 4.25% interest rate in the market.
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The lender will say that we have basically lost 2% in the next few years. Therefore, we will charge you a fine to compensate for our losses, which could be a significant amount of money for the homeowner.
The calculation method for Interest Rate Difference (IRD) is to calculate the difference in interest you need to pay over the remaining term between the current contract interest rate and the new market interest rate. If the interest rate drops significantly between the homeowner signing the mortgage and considering default, Tran said the penalty would be "much greater," especially if there are still many years left until renewal.
Calculation method of penalty for mortgage loan default
Floating rate loans: The penalty is usually three months' interest, calculated based on the contract interest rate or market interest rate, depending on the loan provider.
Fixed rate loans: In an environment of declining interest rates, banks may choose to use IRD to calculate penalties, which is the difference in interest between the contract interest rate and the market interest rate. If the remaining time of the contract period is long, the penalty for interest rate differences may be quite high.
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How to Reduce Mortgage Loan Default Penalties
Porting mortgage loan: If buying a new house and selling an old house, you can consider transferring the original mortgage loan to the new house to avoid termination penalties.
Blended Rate Loan: For homebuyers who require a higher loan amount, the lender can offer a "blended rate", which combines the existing loan interest rate with the current market interest rate to avoid termination penalties.
For example, suppose someone has an outstanding mortgage loan of 150000 yuan with an interest rate of 6% and wishes to raise another 150000 yuan at the current 4% interest rate. Then, the lender may offer a mixed interest rate of 5% on the total 300000 yuan mortgage loan. This will also exempt any fines for violating existing contracts.
Early repayment: If there are additional funds before termination, it may be considered to repay a portion of the loan principal in advance, which can correspondingly reduce the penalty that will be faced. For example, if you repay 15% of the principal, your penalty costs can be reduced by the same percentage.
Changing loan providers: Some new lending institutions may offer up to $3000 in fee offsets to help alleviate the financial pressure caused by fines.
Tran warns that fines are not the only factor to consider for Canadians who are eager to take advantage of lower interest rates in refinancing transactions.
Even though the upfront payment impact of fines is worth it in the long run and can save money on the remaining term, he pointed out that setting up a new mortgage will also incur other costs: legal and assessment fees, property insurance, and the process of re evaluating eligibility from scratch.
He said, "This is basically another round of going all out. But as long as it's cost-effective, some people will do it. So the short-term pain may be exchanged for long-term benefits
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