Blending and Extending
Posted by Gail | Filed under Credit Wise, Home Buying
I’ve been getting a bunch of letters from people recently about taking advantage of the new, lower interest rates. Here’s one from Kristina:
Today’s mortgage rates have my husband and I tempted to refinance our current mortgage. We are 17 months into a 5 fixed year term, 25-year mortgage. When we bought our house, the 5 year fixed rate was 5.75% and now it is 4.09%. This is a difference of $320 a month, an amount that would significantly accelerate the down payment of the mortgage. I have read that we can expect that the bank will want 3 months interest in penalties if we try to get out of our current mortgage. Is this always the case or are there any other options that we can explore? When does it make sense to refinance?
When you’re trying to decide what interest rate and term to use for your mortgage a whole bunch of factors come into play:
- There’s the difference between the rate for a variable mortgage and one for a fixed-term mortgage, along with
- The different terms being offered, usually anywhere from six months to 5 years (or in some cases even longer), as well as
- The choice to go with a closed mortgage or one that is open and can be repaid early.
From the lender’s perspective, the rates reflect where interest rates are headed. Usually longer-term rates are higher than shorter-term rates, but the yield curve can become inverted if the economic gurus are predicting that rates will be coming down over the long term. And usually, variable rate mortgages are less costly than closed, fixed-rate mortgages. But those closed, fixed-rate mortgages also protect you from interest rates that head upward during your term.
If you choose to go with a closed mortgage and then watch interest rates drop, as they have over the past few months, you may feel like you’ve been cheated since your mortgage is going to cost way more than it needed to. If only… if only you had known interest rates were going to fall, you’d have gone with a variable rate… if only you had known rates were declining, you’d never have committed to such a long term at such a high rate… If only…
Quitcherbitchin people. You looked at the info at hand, made a decision and now must stick to your side of the bargain. If you try to get out, the lender will hit you with a big fat penalty – called a “lost interest compensation, or LIC” – because you’re breaking the contract.
Some people are very willing to eat the LIC, adding it into their mortgage so they can get the lower interest rate for a longer period of time. Hmmm. They argue that the longer-term savings on their mortgage is well worth paying the LIC.
If you’re determined to renegotiate your mortgage, let me introduce you to the concept of the “blend-and-extend.” With a blend-and- extend, you continue to pay the existing interest rate for the remaining term on your mortgage, but you renew early to lock in the lower rate for the remaining term.
Let’s say you have 18 months to go on your mortgage at 5%. For argument’s sake, the current 5-year rate is sitting at 4%. If you used a blend-and-extend, you’d pay 5% for the first 18 months and 4% for the remaining 3.5 years on your new 5-year term.
Most lenders offer the option to blend-and-extend. They may not know it, but they do. And you may have to convince them that this is something they can do, since the financial world is sadly under-educated in terms of how stuff works, and what their own companies offer. Hmmm.
You must be persistent. Your persistence will be rewarded with big savings. Brenda wrote me to say:
You are a peach! Dear Gail your advice has saved me $2,259.70 blending and extending mtg, and I negotiated a rate of 4.638 from 5.1 based on $214,515. locked in for 5 yrs closed. It took a lot of wear on the branch mgr, but TD came through.
So, are you going to beat yourself up for not having the foresight to predict where interest rates were going? Are you going to bitch and complain about how lenders are greedy dicks? Are you going sit there wondering how long the lower interest rates are going to last? Or are you going to find a way to capture those lower rates right now, so there are fewer surprises in your future? Hey, hindsight is 20/20. It’s what you do with the information you have in the here-and-now the separates the whiners from the winners.
BTW: A lot of you have been indicating that you’d like an opportunity to get together and meet me in person. Saver Queen is making plans for a Potluck in the Park. There’s a forum set up under Gail Clubs (all the way at the bottom), and if you’re interested in participating, you can go there and get into the mix. I’m coming, and bringing kids with, along with a nice salad. Saver Queen has been good enough to front the costs for the park permit, and we’re all going to chip in. Go check out the forum!
March 24, 2009 at 9:48 am
Very timely post for us! We are going to renew our mtg today and I have been hitting my head against a brick wall about what to do: lock in or not? Your article gives me more information to evaluate the rates with so I feel like we will be making an informed decision. Not just a “panic” reaction to the rate fluctuations. Thank you!
March 24, 2009 at 10:08 am
We have owned our property almost 9 years. Ideally we should have only been coming to end of our 2nd 5 year term of our mortgage. But we have renewed our mortgage a couple of times, early to take advantage of rate changes. Smart? Probably not, but at the time it was what we needed to do. Almost 3 years ago we renovated our home. Long story short, we were $25K short of what we owed from what our mortgage was. My father was able to loan us the money to bring up the shortfall. Our mortgage lender at the time of the renovation treated us extremely unfair and I vowed not to renew with when the time came. My father was extremely understanding, but 2 years after the renovation, he is now looking at retirement and has “called in the loan” so to speak. With the interest rates the way they are we thought that since we were at 6.3%, and have paid down some of the mortgage we might be able to refi and hopefully put the $25K into the mortgage where it should have been in the first place. We managed to find a lender willing to take our house value at face value and were all set to move our mortgage. We were signing papers with the lawyer and realized that we were being charged over $9K for the penalty. I freaked. We knew that there would be a penalty – in the past it had been 3 months interest – but this charge was outrageous. We came home and called the lender and asked them what the penalty would be – I was told about $6K (ok – high since it was actually more than my 3 months worth of payments but more in line with what we thought it would be). Then I told them about seeing the $9K penalty and wanted to know what it was about. I am now familiar with a little clause called the “IRD”, Interest Rate Differential. It is the option that the lender has to be able to recoup the difference between your interest rate and what interest rates have (in our case – dropped) gotten to. To say the least, we put the brakes on the deal. I was furious that this lender was again going to screw us around trying to get out the door. Much to our surprise, the interest rates dropped again the next day. Our mortgage broker was shocked but started working on something else for us because of what was now happening in the industry. Since we weren’t really in a hurry (no house to buy/sell etc) we were able to sit and see what happened. Our mortgage broker found a new offer of 0.6% + prime offered by 2 lenders. Our current lender (oh goodie!) and another lender. Our broker tried to get our current lender to waive the penalty to just 3 months rather than the IRD. No go. Your kidding me? The way the economy is and you don’t want a mortgage the size of ours on your books for the sake of sticking it to us for a difference of $3K? Really? Fine. No way I was going to renew with them for the new mortgage with paying a $9K penalty. We went to the other lender since with our current lender we were always treated differently since my husband is self employed. We are now with a variable rate that has dropped twice since we closed our mortgage in January. Was it supposed to happen? Probably not, but we will save our penalty paid within the first year dropping from 6.3% to 4.1% and now that interest rates have dropped even more our original accelerated payment that we had set up at the first rate continues to grow as the rate drops and hit the principle even more. We probably haven’t been very smart with our mortgage (its still way more than I would like it to be) but now that I am learning a lot more with the help of Gail’s info I will have more information in hand when we go to renew our mortgage in 5 years. Despite the fact that we bought the property in 2000 and still have a 22 year amortization (starting from 2009), I am working on making payments that will still have our house paid for before 2025.
March 24, 2009 at 11:05 am
We’re in year 4 of a locked 5 year mortgage. When we got our rate, we got a fantastic deal at the time. Even though interest rates have gone way down, I’m glad we chose fixed over variable. We may have saved some money, but there is something to be said for knowing you will be able to afford your payments no matter where the interest rate is. We over pay our mortgage, and I don’t lose any sleep!
Lucky people who get to meet Gail! Wish I could attend the potluck, but its not in the budget (I suppose I could charge the airfare but I don’t want to meet Gail for a V8 slap!). However, if Gail ever wants to head out to the east coast we’ll throw a kitchen party like there never was!
March 24, 2009 at 1:25 pm
Hi Gail,
Umm, about 7 years ago, and 1 house ago, I recall going to my lender at TD regularly when interest rates would drop and she would blend my rate (existing with the new lower one) to get a new interest rate – lower than the original, but higher than the new lowest one posted. I had no problem doing it, I would just go and ask and she’d do it – there was no penalty, no questions nothing! Is that still possible? I would like to try it as I am locked in for another 4 years at 5.3% – and sure, I would like to blend now and reduce that somewhat. Anyone know about this – or do it? I’d love to know.
March 24, 2009 at 1:35 pm
mllmac, what you are asking is EXACTLY what Gail was talking about. Your TD manager blended your rate with the new one. This is why it is called Blend-And-Extend.
March 24, 2009 at 2:13 pm
hmmm…my comment seems to have disapeared.
I will try again.
We did the blend extend thing in 2005 and took off nearly 1.5%!!! We are up for renewal in mid 2012, the rate is with 1% of the better posted rates at the canadamortgage website (A GREAT resource for anyone shopping rates right now)
I am NOT a person who likes taking risks, so I have always preferred to long in as long as possible. i don’t regret it for a minute.
In 10 years (or less) we will OWN our home! Now if only I can stop looking around…
March 24, 2009 at 2:27 pm
We are fortunate to have the variable rate mortgage at 2% right now, with the option to switch to a fixed rate, 5 yr term at any time. So my question is kind of the opposite of this…when would be a good time to go from the current low rate to a higher (but still low for a fixed rate) fixed rate? The bank is offering a 10 year fixed at 5.25, or a 5-year fixed at 5.55 (-1% discount for switching to a 5-year fixed). I’m pretty comfy right now, but was considering switching as soon at the interest rate started to move up. Good idea?
March 24, 2009 at 2:28 pm
Hi,
We recently had to renew our Mortgage, that was up as of March 1st. We had approx. 89,000.00 left. Instead of renewing our Mortgage @ 4%. We added it to our line of credit which is @ 2.5% intrest (always at prime) so lately it’s been decreasing. We increased our bi monthly payments, and should have it paid off with in 4 yrs ( this includes the intrest). My question is as long as we’ve had our LOC its been incredable low @ prime. Does prime ever go higher than 4 or 5 % nad does anyone think that will happen in the next couple or years?
March 24, 2009 at 2:45 pm
Catherin, you can lookup historical prime rates easily in google, but yes prime can go as high as it needs to in the eyes of the bank of Canada; 1995 it was at 9% and in the 1980s oh boy! But I like to think it’s more about the balance than the interest rate and you have a teeny tiny balance compared to most people here (myself included). I think you’ll have it paid it off before rates rise significantly. My wife and I locked in at 5 years in June 2007 and my inclination was to go variable but you know, we were selling our first place, buying our first house, having a baby, and switching jobs so I had a lot of variables and wanted a certainty. I looked into breaking our mortgage but it would cost a lot and since we had a pretty good rate even compared to what’s out now we just decided to make lump sum payments of the penalty amount which will bring our balance to what it would be if rates remain the same as they are now. Is it a good solution? Well not the best but at least I can sleep at night as Gail says.
March 24, 2009 at 2:46 pm
PS for the rest of our mortgage’s hopefully shortlife (12 – 15 years) hopefully, we’ll go variable unless I have another worlds in collision moment in 2012.
March 24, 2009 at 4:18 pm
I am a lender/investor for a bank and we do blend and extend all the time…what you are blending is the Interest Rate Differential (IRD) with the new lower rate…I do still discount the new rate so it usually works out better for the client BUT, you do have to be careful with the rates going so low now sometimes the IRD is so high that even with the discount on the rate the blend and extend would not be lower than your current rate…but, your advisor will let you know this…I check this out for a least one client per day these days…it only takes moments and as advisors we have no problems doing it…no need to beg plead or threaten at all..lol…
March 24, 2009 at 4:37 pm
Thanks Geoff for your input, I was a little nervous at the time that we did this, but I loved the idea that we could increase our payments and add extra payments when we had had extra monies.
My husband and I are are really keen on get our mortgage paid down as fast as possible. I’ve never heard of anyone putting their mortgage on their LOC, before we did. Is this common?
March 24, 2009 at 4:57 pm
Catherine,
Yep, paying out a mortgage through a loc or heloc is fairly common and sometimes is the best recommendation depending on rates…having your loc at prime right now is great…more of your payment will hit the principal instead of the interest fast tracking the payout of your debt!
March 24, 2009 at 10:30 pm
I’m calling the bank tomorrow to try my luck. I have nothing to lose.
Even if I eat the three month penalty, I will probably be ahead in the long term. For those that are interested to see if it is worthwhile to renegociate their mortgage, check out industry canada’s morgage saving calculator at http://www.ic.gc.ca/eic/site/oca-bc.nsf/eng/ca01817.html . A three month interest penalty could save me $12,000 for a few days of work.
March 25, 2009 at 1:43 am
Gail, I absolutely love your show. While I don’t understand all the financial aspects of it, I love the concept and how you explain to people to make things work. I more or less let my husband deal with the finances, paid a bill when he told me to, etc, that’s about it, but he died in November and now I’m confused about everything. I don’t know what’s what and just trying to look at all the paperwork is depressing especially since it makes no sense to my little non-mathematical brain. I’m in Manitoba, and I know you mostly air your show out in Vancouver. Not that I’m television material or anything, but if you’re ever in Manitoba, I hope I hear about it!
March 25, 2009 at 7:09 am
I’m closing my new mortgage on May 1. I’ve chose a mortgage that 1.) lets me increase my payments by 25% a year, plus put a lump sum payment of 20% of the principal once a year too. If I just put the 20% down my mortgage will be paid off in 8 years, but if I increase my payments and put money down it will be even less than that. So I’m going to bite the bullet and increase my payments ASAP and hopefully own my house outright in 5 or 6 years…
March 25, 2009 at 9:43 am
ter:
Sorry for your loss. Check the Gail Clubs link and see if there is one in your area. Maybe someone can help you with the money part.
Good luck!
March 25, 2009 at 11:33 am
Ter–I have started a Gail Club for Winnipeg/Manitoba. Check it out and maybe we can help!
I’m so sorry for your loss.
March 27, 2009 at 1:01 am
I had to break our morgage a month ago, and put our loans on the morgage. The penilties were high (5,000), but we were going to almost break even or perhaps even save some money by getting the lower rate. Thank goodness, because now all of our payments are lower, and hopefully one day soon we can start aggressively paying down the morgage again.
April 3, 2009 at 12:03 pm
I think people considering changing/breaking their existing mortgage really need to do their own calculations and not simply ‘listen to what the bank says’. Sure you save money with a blend and extend, but if you can afford the break penalty, you’ll very likely be better off.
Inevitably, all scenarios I’ve gone through for changing our 5 year fixed (5.79% – 1.3 years in) – paying break penalty, paying a ‘renewal penalty’ (i.e. break but stay with same lender and full mortgage amount is at lower rate) – you come out on top if you can pay the penalty (don’t blend and extend) – and then use the additional cash flow to pay down principle amounts.
With this strategy, you’ll pay down the mortgage sooner – and you have the added flexibility of lower minimum payments if needed.
April 3, 2009 at 2:21 pm
Sampson, the only downside to your strategy is that most people roll the penalty into their mortgages and then do NOT prepay the principal, choosing instead to keep the spending room in their cash flow. In the end they save nothing because after lowering their interest costs, they rack up the interest over the long-term amortization, or worse, by further consolidating debt into their mortgages. Oy!
April 7, 2009 at 10:06 pm
We just renewed out mortgage. Our original interest rate was 6.15% and we were paying accelerated payments. We locked in to a 5 year term at 4.25%. We left our payments the same so we’re really paying off the mortgage – kind of like ‘double acceleration’.
It will be paid off in a little over 15 years. We started off with a 25 year amortization so that saves us a lot of money.
I was so nervous about our mortgage renewal. I’ve been reading horror stories on line. It was a piece of cake though. Thought about going variable but we are more comfortable with the fixed rate.
April 23, 2009 at 4:55 pm
We have a 5 year mortgage (280K) (started Apr 2007) at 5.25% (25 yr amortization). Would like to take advantage of rate decrease. Have been offered a blended 5 yr mortgage by BMO of 4.95%. I thought we could get lower? or is this ok? Or second option 3.85% over 5 yrs (but pay penalty of $11K). All advice appreciated.
Pat
April 28, 2009 at 3:37 pm
I absolutely agree with you Gail – you have to very disciplined with paying down the mortgage to benefit from any options where you pay the penalty (either out of pocket, or rolling into the new mortgage).