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Buyer Beware: Converting A Variable Rate May Cost More At A Bank

Sep 16, 2008
A variable rate mortgage loan is attractive to home buyers for a number reasons, not the least of which includes the significant savings over fixed rate mortgages. Depending upon the market, the difference between an initial rate on a variable rate mortgage and a fixed rate can range from 1 to 1.25 percent. That's a significant savings, whether you are a first time homebuyer or an investor.

The trick to making a variable rate mortgage work for you is to purchase a variable rate mortgage with an option to convert to fixed rate at some point in the future. When the interest rates cycle down, switching to a fixed rate mortgage ensures you keep your payments low, even after rates begin to rise again. Do you have the expertise to time your decision correctly? Are you confident you'll receive the most competitive fixed rates available and that you are being offered sound financial advice?

Mike Averbach of Averbach Mortgages cautions, 'Converting your variable rate mortgage may cost more at a bank.' The initial rates offered at a bank or credit union may be very competitive. Later, when you decide to lock in to a fixed rate, you may find yourself at a disadvantage. As a consumer, acting on your own behalf, you probably won't be told by the big banks and credit union about all the options that are available.

Contrary to what buyers believe, many banks have no obligation to give you their prime market rate. Many bank agreements do not state in the contract that you will receive their best rate. Instead, at conversion from variable rate mortgage to fixed rate mortgage, banks often offer a posted rate or a rate that is slightly discounted off the posted rate. Because of this, buyers can end up paying more interest than they need to, ultimately losing money over the life of the loan.

What is the difference, in terms of dollars, on an average mortgage based on these facts? Let's consider a situation where a buyer is paying on a $250,000 mortgage with a 25-year term. The borrower has a five year variable rate mortgage and decides to lock in after one year. Converting to a fixed rate mortgage after one year, at .25 percent higher than the best market rate equals $625 per year in additional interest costs. Over four years the buyer is paying an extra $2500 in interest. Over 25 years that amounts to $15,625. It's just doesn't make sense to spend that much extra money if you don't have to.

Mike Averbach says, 'Buyers assume incorrectly that their big bank will treat them fairly or give them a good discount because they are long-term customers.' What buyers don't understand is that the big institutions and credit unions have NO incentive or obligation to give you, their customer, their best rate. In fact, because they need new business, they have more incentive to treat new clients better than existing ones. You are at their mercy if you refinance through them and they know it!

Once you sign the loan agreement, as an existing client, the mortgage is already a done deal; you are essentially locked in for the life of the loan. If you want to convert to a fixed rate mortgage, the bank can offer you their posted rate - NOT necessarily their best rate. If you decide to finance a new mortgage loan through another lender, the bank will very likely charge you a substantial penalty for paying off the mortgage early. It's a win-win situation for the bank. You are left paying more than you need to and the bank wins either way.

How do you prevent paying a higher interest rate when you convert from a fixed rate mortgage? Mike Averbach advises, 'Do your research either before entering a mortgage agreement, or when renewing your mortgage.' Make sure your agreement has the crucial clause in the contract stating the 'Client will receive the best rate upon conversion to a fixed-rate mortgage.'

Many mortgage brokers work with lenders who are willing to make a commitment in writing to offer their clients the institution's best rate whenever clients choose to lock into a fixed rate mortgage. Even knowing this, some brokers still offer variable rate mortgages from the big banks purely because of brand recognition. That's why one of the most important decisions you make when financing your home is selecting the best mortgage broker. Averbach Mortgage Brokers fits that bill. We have your best interest in mind. Your needs and desires are our main concern.

Mike Averbach, Accredited Mortgage Professional at Averbach Mortgages, can be contacted via email at mike@averbachmortgages.com or by phone at 604-710-2550. Averbach Mortgages' Mortgage Manager, Justin Blacklock, can be reached via email: justin@averbachmortgages.com or at 604-707-6339. Justin, Mike and the entire Averbach Mortgages Team will explain the fine print in mortgage loan documents. They will help you chose a mortgage that truly reflects your situation and respects your best interest.
About the Author
Averbach Mortgages has proudly been serving businesses and families across Canada since 2004. Customer service is the founding pillar of the Averbach brand, our organization's success has been built entirely on referral based business.
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