Although there are circumstances where it makes sense to bite the bullet and pay the penalty for a Mortgage Renewal, it certainly makes sense to review all the alternatives before you renew.
Maroney on Money for June 16, 1996
One option is to blend the rate on your existing mortgage with rates currently being offered. In essence you are renewing your mortgage early at a rate that is lower than the rate you are now paying but higher than current rates. Early renewal is especially attractive if you believe current mortgage rates are low but you expect them to increase before your existing mortgage comes up for renewal.
To renew early you must have more than one year left on your existing term and the "renewed" term must be longer than the existing term.
Consider last week's example of a $100,000 mortgage at 9% amortized over 20 years with 3 years left before renewal. Recall that the penalty to be paid on discharge of this mortgage would be $2,437.
Assume in this case, the individual is concerned that interest rates will be higher three years from now and wishes to extend the mortgage term to five years. Five year mortgage rates are currently in the range of 8.0% to 8.5% at most financial institutions.
Using a five year rate of 8.5% and skipping the detailed calculation, the blended rate on this early renewal will be 8.8%. If the monthly mortgage payment is kept the same, early renewal will generate an interest saving of $640 at the end of three years, being the date the initial mortgage would have come up for renewal. In other words you would have reduced your mortgage balance by $640; in essence paying yourself instead of the bank.
The numbers may appear to be small, however, all things being equal and rolling forward to the end of the mortgage amortization period, early renewal will have saved this individual almost $7,600 and reduced the mortgage amortization period by eight months.
At the end of five years the principal balance outstanding on this "renewed" mortgage would be $87,634.
If we compare this with the alternative of paying the penalty and renewing the mortgage at 8.5% for five years, the decision is clear. Assuming that the penalty would be added to the original mortgage balance, the principal outstanding at the end of the five year term would be $89,641 which is more than $2,000 higher than the mortgage renewal amount.
But what if you have the cash to pay the penalty up front thereby eliminating the need to add the amount to the mortgage principal? Should you discharge your existing mortgage or renew your mortgage at a blended rate. As far as I'm concerned the answer is neither. In my opinion, your best choice is to make a lump-sum payment on your existing mortgage and be patient.
Most economic forecasts that I have seen indicate that interest rates are expected to remain stable over the next few years. In any event, you will still have the mortgage renewal card to play if interest rates start to move upward.
Jim Maroney is a chartered accountant with Andrews, Brown & Maroney in Maple Ridge.
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