Don’t Let Your Ego Get Caught Up on Interest Rates

This post is written by Trusted Partner, Keith Uthe – Mortgage Alliance Enrich Mortgage Group. To become a contributing editor, please contact our Real Estate Investor Solutions Specialist, David Maxwell at david@reincanada.com.

There are currently so many moving parts with mortgage rates and policies that making a decision solely based on a current rate offer could end up costing you thousands. If mortgage rates drop, focusing solely on the interest rate when taking out a loan can still lead to problems in the future. Here’s why:

1. Opportunity Cost of Refinancing
   While a drop in rates can present an opportunity to refinance for a lower monthly payment, refinancing comes with its own costs, such as closing fees, appraisal fees, and prepayment penalties. If a borrower took out a loan with a low rate that came with a discounted rate, as most big banks offer, penalties for refinancing to take advantage of lower rates would be 3-4 times higher than with other lenders that use actual posted rates. You need to ask yourself what you would want to do if rates dropped by half a percent or more. It is certain that paying a slightly higher rate now with a lender using a straightforward interest rate differential penalty for fixed-rate penalties will be much less costly in the long run compared to a bank’s discounted lower rate now. The banks high penalty would be prohibitive to making a change to a lower rate and being able to save thousands in interest in the future.
2. Variable/Adjustable-Rate Mortgage (ARM) Risks
   Borrowers with an adjustable-rate mortgage (ARM) might assume they’ll benefit if rates drop. However, you have to consider the current spread between the fixed rate and he variable/adjustable rate to calculate how much extra you will pay on the variable/Adjustable compared to the fixed rate per year and how much would the prime lending rate have to drop to be able to break even on the overpaid interest and what would it take to be ahead. This means you might not see the full benefit of a variable/adjustable rate even if the prime lending rate is decreasing. Conversely, if the market becomes overheated in a rising economy, the prime rate could rise later, and your payments could still increase. No one has a crystal ball.
3. Loan Structure and Terms
   If rates drop and you have a long-term fixed-rate mortgage, you may want to refinance to take advantage of lower rates. However, if you focused only on the interest rate when you first took out the mortgage, you may have missed the chance to choose a loan with more favorable terms (like a flexible prepayment option). The cost and complexity of refinancing could make it less appealing despite lower rates.
4. Equity and Market Conditions
   Even if rates drop, refinancing might not be an option if the borrower doesn’t have sufficient equity in the home. If the home’s value declines or if the borrower has only made minimal progress in paying down the principal, they might not be eligible for refinancing at better rates. Additionally, market conditions can influence a lender’s willingness to offer favourable terms. This is why discussing your options with a mortgage broker is critical to fully understanding your strategy and opportunities.
5. Longer-Term Implications
   Focusing on interest rates can lead borrowers to overlook how other loan factors impact their overall financial health. For instance, if rates drop but you’ve taken on too large a loan based on initial low rates, you may still need help with high monthly payments, leaving little room for other financial goals, even with refinancing. If you are growing a real estate portfolio and you use a lender purely on rate, that could prevent you from growth as that lender may have a more favourable allowance on the number of properties allowed, which you need later in your growth rather than now.
6. Missed Opportunity for Short-Term Gains
   If rates drop but you took out a long-term loan without considering how a shorter-term loan could have accelerated equity-building, you might miss out on financial flexibility. Borrowers who only focus on interest rates might not consider that they could have structured their loan differently to take advantage of lower rates later by paying off their loan faster.

In essence, even in an environment where rates drop, focusing solely on the initial interest rate can limit one’s ability to fully take advantage of future rate reductions or create missed opportunities for long-term financial benefits. To discuss your strategies, options and opportunities contact me keith@enrichmortgae.ca or Book A Discovery Call: https://calendly.com/keithuthemortgages