Residential Mortgage Rate Averaging
“Here’s Another Strategy To Consider When Looking To Protect Against Higher Residential Mortgage Interest Rates”
One of the challenges with trying to lock in a long term interest rate when you already have one in place is that the prepayment penalty associated with paying out the existing mortgage with a new mortgage is cost prohibitive in many cases.
This is because most mortgages charge an interest differential penalty that calculates the difference in the current rates versus your existing mortgage rates times the amount of time left in your existing mortgage term (the math is a bit more involved, but what I’ve described above provides the basic idea).
Just from a logical point of view, this type of penalty does make some sense as the mortgage lender had to acquire the funds from somewhere in order to provide you with a mortgage. Those funds came at a cost, and the mortgage lender needs to maintain a margin between their own cost of money and the interest rate they loaned the money out at. If they didn’t do this, every time borrowers wanted to move to a lower interest rate, the lender would lose their shirt as they would still need to pay the same original cost of financing on the money they borrowed, but would not be able to re-lend it out at the same rate that your original residential mortgage was written at due to the fact that rates are now lower.
Conversely, as rates rise, the interest differential calculation will drop as the gap between the current rate and your existing mortgage rate will narrow.
So if I’ve totally confused you, I apologize. All you really need to understand is that if you are locked into a higher interest rate term on your existing mortgage, you’re likely going to have to pay a penalty for paying out the existing mortgage early if the current market rates are lower than your mortgage rate.
So other than paying the prepayment penalty, what else can you do to lock in a lower long term interest rate?
One strategy is to ask your mortgage lender if they have any mortgage rate averaging or blending programs available. These programs, which can fall under a variety of names, essentially take your current mortgage term and average it with their posted long term rates to come up with a combined rate that is lower than what you’re paying now and can be locked in for years into the future, depending on the length of time you pick.
Under this type of strategy, you’re undergoing rate averaging, not mortgage refinancing.
The net effect is that you still end up paying the interest owing for the remainder of your current mortgage term, but get to take advantage of the existing lower term rates for the future period you’ve chosen without having to shell out any cash in the form of a prepayment penalty.
About the Author Joe Walsh
I'm a Toronto Mortgage Broker that arranges mortgage solutions on residential and commercial real estate property. With over 30 years of mortgage financing experience, I'm able to quickly assess your financing requirements and provide relevant solutions for your immediate consideration. Joe Walsh Google+ YouTube Channel