6 Reasons Why the Best Mortgage For You Might Not Be the One With the Lowest Rate

"Interest rates are prices, and sometimes you get what you pay for."

One of the questions that I get asked all the time, which stumps me a little bit more than you might think it should, is "what is your best mortgage rate?". Typically when people ask this question they mean what is the lowest rate that I have access to, and while it should be easy enough to answer, the truth is that this question represents a common yet fundamental misunderstanding about mortgages and interest rates.

What many people fail to understand is that the best mortgage product is not necessarily the one with the lowest interest rate. This is because interest rates are prices rather than the product itself, and sometimes you get what you pay for. While this might not be as obvious when it comes to mortgages, people tend to more intuitively understand that the cheapest car on the lot is not necessarily the best deal to be had or the cheapest house on the market is not always the best home for your family.

When you finance real estate with a mortgage, you are signing a contract that allows you to borrow a predetermined amount of money (the principal), to be paid back over a certain amount of time (the amortization), for a given price (the interest rate), and that is how your monthly payments are determined. People understand that a lower rate means lower payments and think that's all there is to it, but in reality there is a lot more going on "under the hood" (in the terms and conditions) of the mortgage contract that can add to or detract from the value of the mortgage product as a whole.

The mortgages with the lowest rates tend to have the most restrictive, inflexible contracts and usually offer the least in terms of special features and customer experience. While there are plenty of benefits to lower rates and payments, here are 6 reasons why the best mortgage mortgage for you might not be the one with the lowest rates.

  1. Payout Penalties
  2. Prepayment Privileges
  3. Lending Programs and Special Features
  4. Underwriting Criteria
  5. Insured vs. Uninsured Lending
  6. Lender Response Time

1) Payout Penalties

Payout penalties are number one on this list for a reason. The mortgages with the lowest interest rates very frequently have inflexible and expensive payout clauses which can quickly erase or exceed the amount saved through lower payments. It is a common misconception that you can sell your home and pay out your outstanding mortgage debt any time you choose. In reality, if you choose to pay out your mortgage in between renewal intervals (typically every 5 years), you will incur a payout penalty in doing so, and these can get quite expensive.

While all closed mortgages will have payout penalties, those with very low rates which are marketed as "Value" or "No-Extras" type mortgage products tend to have the most expensive and inflexible ones. In these mortgages you are basically locked in until renewal time with very few options to sell or refinance. You might have no plans to sell or refinance at the time of signing the mortgage contract, but you never know what life is going to throw your way and plans change all the time.

The big banks in Canada are also notorious for outcompeting other lenders with lower rates and then earning their money on the back end with higher payout penalties. 

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2) Prepayment Privileges

If your goal is to have the lowest possible payments per month, then going with a low rate is probably your best option, however if your goal is to pay off your mortgage the fastest with the least amount of interest expense, then there are other options that you may want to consider. This is because "Full Feature" as opposed to "Value" mortgages typically have much more favorable prepayment privileges.

Prepayment privileges set out the conditions under which you are allowed to make payments against your balance in addition to your regularly scheduled payments of principal and interest. The benefit of making prepayments is that the money goes directly towards reducing your balance rather than paying interest. This will pay off your mortgage faster as well as reduce the total interest charged to you over the lifetime of the loan.

Low rate "Value" mortgages tend to have very rigid payment structures and not offer much in terms of prepayment privileges. This means that you are stuck paying down your mortgage at exactly the pace you agreed upon when you signed the contract and have few options to save additional interest expense or pay off your mortgage faster than you initially planned.

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3) Different Lending Programs and Features 

In any given market place, products with more features, functions, and options are going to cost more than more basic comparable products, and with mortgages it is no different. Mortgages with lower rates tend to be more basic and offer less when compared with more specialized mortgage products. 

For a range of different interest rates, some of the more specialized mortgage products that are available are: 

  • Cash back programs (to pay off high interest debts and cover moving and new home costs).
  • Purchase-plus-improvements programs (to roll the costs of immediately-after-purchase renos into the mortgage).
  • Readvanceable lines of credit (to allow you to re-borrow against the equity of your property as you pay your mortgage down).
  • Reverse mortgage products (a mortgage that grows over time and makes payments to you from the equity in your home)
  • Long close and draw construction financing (for new builds that will be completed in the future).
  • Real estate investment financing options (for purchasing rental properties and other investment strategies involving properties that won't be owner occupied).

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4) Different Underwriting Criteria

Sometimes, the best rate is the one that you can qualify for, and depending on the situation, that isn't always the case with the lowest interest rates. The lowest or most competitive rates tend to be reserved for buyers and properties that lenders deem to be low risk. For lenders that means standard full time employment, good credit, low debts, and highly marketable residential properties that conform with municipal standards.

For self employed buyers, non-standard income sources, people with less than perfect credit, foreign buyersnon-conforming properties, or vacant land, there still may be mortgage lending options available to you, but you will end up paying a higher rate than the lowest rates you see advertised (depends on situation). This is because these types of situations are viewed as higher risk from a lenders perspective. With higher rates (and often down payments), lenders are willing to take on more perceived risk.

There is also often nuances and small differences in underwriting criteria for the deals that different lenders will and will not consider for any given area of lending. Certain lenders may be able to consider deals that others won't which may justify paying a slightly higher rate than what the first choice lender is offering if it means the difference between approved and declined.  

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5) Insured vs. Uninsured Lending

Mortgage default insurance protects the lender against borrower default and is paid for by the borrower with a lump sum premium that gets added to the balance of the mortgage. Since it reduces risk for the lender they are able to offer lower rates, but the savings in interest expense rarely make up for the additional cost of the insurance. 

For mortgages with less than 20% down payment, mortgage default insurance is always required, however when there is more than 20% down payment, there are some situations where you may be able to choose between insured and uninsured (conventional) lending. While insured mortgage rates tend to be lower than conventional rates, conventional mortgages are still typically cheaper because you don't pay for mortgage default insurance, so you borrow less overall. 

Additionally, since conventional mortgages don't have to conform with mortgage insurer guidelines, there is usually more flexibility and options than with insured loans. On the other hand conventional mortgages may be more difficult to to renew at the end of the mortgage term.  

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6) Lender Response Time

The lenders with the most competitive rates tend to be the busiest, so when time is of the essence, the lenders with less competitive rates might be able to act quicker. Lenders have application processing cues, and when things get busy, the time it takes for them to review your documents and issue a commitment to lend can increase. This can be a problem in a "hot" real estate market when good properties go fast and sellers want firm deals with quick closes.

Sometimes it can be worth it to accept a slightly higher rate (a few hundredths of a percent) and bypass a long underwriting cue with a different lender in order to get approved and close on a good deal quickly. A good mortgage broker can help you anticipate document processing bottlenecks and place your application with a lender that will get to it quickly.

 

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How to Make Sense of it All?

With so many different choices and options it can be overwhelming to make sense of it all and feel confident in your decisions. Mortgage brokers have access to a wide variety of lenders and mortgage products and at no cost to you can help you find a mortgage that suits your needs and plans. We can guide you through the application process and help you avoid common pitfalls so you can act with clarity and confidence. It all starts with a conversation about your objectives.

Feel free to reach out through our website today and we'll be happy to help get you pointed in the right direction.

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