Interest rates are very low, almost everyone who holds a mortgage is thinking about refinancing to lower their monthly payments and interest paid. One of the major road blocks is the penalty imposed by mortgage lenders. In some instances the penalty maybe $50,000 or higher, making the refinancing seem irrational. Simple calculations will reveal the fact that even taking the substantial penalties into account mortgage refinancing may still be beneficial. This guide will illustrate the step by step process of lowering the discharge penalty.
Prior to proceeding secure the following information:
- Your mortgage pre-payment privileges.
- Your mortgage penalty before and after exercising the privileges.
- If the lump sum pre-payment limit resets at the end of calendar year (January 2009)
Note: Contact us if you have any questions with calculations. (http://www.Ratebot.ca)
Almost every mortgage has pre-payment privileges. For the purpose of this guide we will assume that your pre-payment privileges are 20/20 (the most common one). That means that you can make a lump sum payment equal to 20% of initial mortgage balance and increase your monthly payments by up to 20%.
- Use pre-payment privileges
- Get approved for home equity line of credit. This will only work if your mortgage balance is less then 80% of the value of your house. State to the broker/lender that you will use the credit line to pay off part of your mortgage using pre-payment privileges.
- Some banks will be able to give you a line of credit equal to 40% of your mortgage balance (2 x 20% pre-payment privilege) even if your mortgage balance is equal to 80% of your house. The bank will pre-pay 20% on the day of funding and will lock the balance of line of credit till next year when the limit resets. This will allow you to do one more payment of 20% when the pre-payment limit resets in January.
- Increase your monthly payments by maximum allowable limit from now till January. This will further reduce your mortgage balance.
- Lock yourself for a rate for 120 days. This way you will be safe if the rates go up.
- Get a full approval for a mortgage so that in January 2010 you are able to refinance your line of credit and 1st mortgage into one big mortgage that you were approved for.
- After completing the first two steps, your first mortgage balance will drop by more then 40%, reducing your penalty by over 40%. For the majority of mortgage holders this would drop penalty by more then 50% and will make refinancing profitable again.
- Refinance your existing credit line and first mortgage into a single mortgage with a new and lower rate.
Hopefully you have found this guide helpful. Below is the list of the costs associated with the process:
- Legal fees to put the line of credit in place (around $500)
- Discharge fee for a line of credit. (around $250)
- Total cost: ~$750 (Can be waived. Ask your lender)
- Result: Total savings 40-60% of mortgage penalty.
