Art of Renegotiating a Mortgage

Rates on mortgages have fallen a lot in the past several months, prompting many people to ask about renegotiating in order to cut costs.

The problem in breaking a mortgage is the penalty that lenders charge. Banks typically have two ways to calculate the penalty and recently they've switched to the more expensive one.

A little context may help you gauge how annoyed you should be about this. With a recession and global financial crisis hurting their revenues, the banks have been pushing up interest rates on lines of credit, charging more in service fees and adjusting credit card rules to extract more money from clients. Mortgage penalties are somewhat different in that they're mainly influenced by what's happening with interest rates.

It's boilerplate in mortgage contracts for penalties associated with breaking a loan to be set at the greater of three months' interest or the difference between the interest the bank could make on your mortgage as originally arranged versus lending money out at current rates.

If you have any thoughts of breaking your mortgage, get on it today. If mortgage rates fall further, and they could ease a little bit more, then interest rate differentials will grow in size and cost you more.

The first step in breaking a mortgage: Ask your lender what your penalty would be. There's no standardized calculation of penalties, so your number will depend on your lender's own policies and personal circumstances like the amount you've borrowed and the number of years left on your mortgage.

Practices vary widely among banks, but one method for calculating the IRD is to compare a client's original rate against the posted rate for the term that corresponds with the remaining time left on the mortgage. Example: You're two years into a five-year mortgage, so your IRD would be calculated using the current posted three-year rate.

Once you know your penalty, ask your lender to show you how much interest you'd save by renegotiating with the best possible current rate. If the penalty overwhelms the potential savings, then you have a couple of options beyond giving up.

One is to try and negotiate the penalty lower, or have it eliminated altogether. Mr. Tourloukis said lenders have the discretion to help clients out this way.

Another is to chop the amount of money you owe on your mortgage, thereby reducing the penalty for breaking the loan. The way to do this is to take advantage of the prepayment privileges built into most mortgages.

For example, you might be allowed to prepay as much as 20 per cent of your outstanding balance in a year without incurring any charges. Make this lump-sum payment and then get a quote on the penalty to break your newly shrunken mortgage.

There are a couple of strategies to look at if you'd benefit from breaking your mortgage but can't afford the penalty charge.

One is to take the cost and add it to your mortgage balance. In some cases you'll still end up paying less interest than if you stayed with your current mortgage.

Another possibility is a blend and extend, where you jump into a new mortgage that blends your existing rate with the lower current rate and extends your term by a few years. There's no penalty charged in a blend and extend, but you won't save as much as you would if you paid the penalty and got the best possible current interest rate.

“If you want the better rate, you have to come up with the cash,” Mr. Gaetano said.

Good article by Robert Carrick of the Globe and Mail which I thought you might find useful as I know a lot of you are thinking, or should be thinking, along those lines.

http://www.theglobeandmail.com/servlet/story/RTGAM.20090211.wcarrick0212/BNStory/SpecialEvents2/robCarrick