Careful What You Wish For

When Janice sold and went to the bank to pay her mortgage off early, she was calm. When she left, she’d lost it. No wonder. The poor girl was done over by a major bank which shall remain nameless, but whose initials are CIBC.

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This is a cautionary tale. There’s a dark side to all that cheap home loan money which has been washing over the country. Did you really think initiatives like BMO’s 2.99 Special were cooked up just so you could save some money? I sure hope not.

Most people understand that getting out of a mortgage is akin to wiggling out of a marriage. It’s usually possible, but often brutal. Common mythology is that your lender will nick you for the equivalent of three monthly payments, but increasingly this is simply not the case. More common is the dreaded IRD – interest rate differential. Typically this means the difference between the mortgage rate and the bank’s posted rate for the same term, over the time left until a renewal. In other words, how much money will the bank lose in interest by letting you off the hook, compared to what it would earn had the money been deployed at current rates?

Simple, right? If rates are higher when you break the mortgage than when you took it, there should be no IRD at all. Just pay three months, and split. But if rates are lower, you have to compensate the bank, which is giving up interest you’d be paying until the term is done.

Fine, thought Janice. This is easy.

She renewed her mortgage just a year ago on a five-year term for 3.69%, with a reinvestment rate for the balance of the term for 4.39%. Janice was happy with that deal, since at the time the posted 5-year rate was 5.19%. In order to keep her as a customer, this unnamed bank chopped a point and a half off the cost. Nice guys!

Since then, rates have eased. The bank today offers a fiver for just 4.04%, which is lower than 4.39%, leading our gal to naturally think she’d be walking away after paying a three-month penalty of $3,500.

Forget that. Instead, she was handed a bill for $12,565, and freaked. Turns out CIBC determined the IRD not as the difference between the rate you were offered, and current rates, but rather the posted rate when you borrowed, and the rate you actually got. For Janice that meant the difference between 5.19% and her 4.39%, over four years left in the term. Bingo. Twelve grand.

Listen to  Janice’s mortgage broker – the person who arranged the loan:

“So the bank has the opportunity to lend out this money returned to them for  4.39% for the balance of the term. By my calculation, the lender would have earned $53,441. if the current mortgage had been left to maturity. As it was paid out early, the lender will earn $12,565.03  plus the interest at 4.39% for reinvesting the funds for the balance of the term of $63,779.  Total- $75,643.00. The penalty is based upon a hypothetical situation and further illustrates the greed of big banks.”

Indeed. It knoweth no bounds. I’m told that at least one lender uses a bond rate (not its own posted loan rate) to determine an interest rate differential. Like I said, a cautionary tale. Never, ever take a mortgage just because it’s got a bitchin’ cheap rate.

Read the fine print. Even better, pay your lawyer to read it. Better still, rent.

Now, a small update on a story I brought you some weeks ago.

You may remember the tale of some sixtysomething Boomers whose only financial asset was a house in the nether regions of Scarborough, which they sold for enough money to pay off all their debts. According to their son (a regular here, which goes to his lack of character) they will end up living in a trailer in a northern Ontario swamp – which he tried to defend as a noble lifestyle choice. I called them financial losers.

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Even more interesting, though, are the virgins who bought the aging townhouse for $414,000 – a couple in their twenties.

Son Carlyle has more. “ So it turns out the kids that bought my parents house 414k both work at Costco!  Apparently their parents will be moving in with them (and no doubt covered the down payment).

“Thought you would find this interesting. The house is going to need a lot of “love” over the next few years … A new roof within 5 years for starters … And the furnace blew yesterday (thank god my parents hadn’t cut the insurance). They are damn lucky to be getting out now, with people buying it at a cost that is far more than the house is worth (in my opinion).  I pity the buyers.  So many people not only overpaying for homes but not considering maintenance costs down the road (not to mention much higher mortgage rates — double whammy).”

More time is spent buying shoes and cars than houses and mortgages. As the cost of real estate soars beyond reason, ironically the cult of home ownership deepens. Pressure from peers, parents and society has turned property into a no-risk, no-lose move in the minds of the virgins. Most never think of physical burdens, the magnitude of the debt, or even an exit strategy. An entire generation has never seen real estate turn illiquid or erode in value. So to them, it cannot happen.

That reminds me. I miss being thirty. I knew everything.