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It's not too Late to Refinance your Mortgage!

A few months ago interest rates plummeted. If your mortgage was locked into a five to ten year term, the idea of breaking that term, paying the penalty, and refinancing at the lower rate began to make sense. It's now January, 2002 and the rates are creeping back up again, but it's not too late. Here are a couple of examples, based on current conditions where I live in Victoria, BC.

Assumptions: you have a $100,000 mortgage with a 25 year amortization, and are two years into a five year term at 6.5%. Your current monthly mortgage payment is $675.21, and over the next three years you will pay $24,307.45 principal and interest.

Example 1

You break the mortgage term. Penalties vary, but assume 1.75%, which is about right. You are out of pocket 1.75% of $100,000 = or $1,750.

You go to a mortgage broker–I'll use Mortgage Depot in Victoria for an example–and get a variable rate open mortgage. Right now Mortgage Depot is offering an introductory rate of 1.01%. This lasts for three months, after which the rate is Bank Prime minus 0.35%–currently 3.4%.

There is a slight risk here, since you will have a variable rate mortgage and if interest rates climb so will your monthly payments. However, this is somewhat mitigated by the fact that you can convert at any time, at no cost, to a fixed term based on the Day Rate.

If interest rates stay low you will have paid off the $1,750 penalty within about a year, and can enjoy the advantages of the lower rates for the next two years. Assuming 3.4%, you would save roughly $4,300 compared to your current situation.

Example 2

If you don't have the wherewithal to cover a $1,750 penalty, or feel queasy about the small risk involved, here is another way to go. Many banks offer a "cash back" option–they will give you a wad of cash up front in exchange for locking in at a slightly higher rate. The advantage to doing this is that the current rates are so low that the higher cash back rate is still likely to be less than the rate you are locked into now.

In fact, this is what I did with my mortgage. I was able to lock in the cash back mortgage for three years at almost a full percentage point under the previous rate. The cash back rate was 2%.

Applying those numbers to the hypothetical $100,000 mortgage, you would pay a penalty of $1,750, but receive $2,000 up front for turning it into a cash back mortgage (2% of $100,000). You would be $2,000 - $1,750 = $250 ahead right off the bat. If you can get a rate of 5.5% for three years (6.5% - 1%), your new monthly payment will be $63 dollars less. Over three years this will save you $250 + ($63 times 36) = $2,518.

Worth doing? You bet!

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