When Bank of Canada pivots adjustable-rate mortgages will benefit

If you want your payment to follow rates lower, you need an ARM. Robert McLister tells you how to shop for one

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Like kids waiting for Santa Claus, floating-rate mortgagors have waited months for the Bank of Canada to deliver savings. Instead, the central bank delivered another lump of coal March 6 — no interest rate cut and little hope of cuts for months.

That means homeowners needing rate relief may not get it until summer, or later. 

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Cash-strapped borrowers will jump on the variable-rate train once that relief finally comes, hoping their payments drop as the prime rate drops. A 100-basis-point rate decline would cut their payments by roughly nine per cent on a 25-year amortization. 

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But falling payments aren’t possible with all floating-rate mortgages. Most big banks sell variable-rate mortgages (VRMs) with fixed payments. If you want your payment to follow rates lower, you need an adjustable-rate mortgage (ARM). 

With a VRM, your payment generally stays the same but the split between interest and principal changes as the prime rate changes. The exception is when rates rise so much that you’re not covering the interest, in which case some lenders do increase the payment.

With an ARM, the principal paid stays the same each month, but the overall payment adjusts with the prime rate.

Here are eight insider tips if you’re out there ARM shopping:

Tip #1 — Adjustable-rate mortgages aren’t always easy to spot

Many lenders sell ARMs, partly because they’re easier to fund than a VRM — for technical reasons which I’ll spare you — but it’s hard to know which lenders do and don’t.

You’ll find ARMs at certain credit unions, CanWise Financial, CMLS, Equitable Bank, First National, MCAP, Merix Financial, National Bank, Nesto, Radius Financial, Ratehub, RFA, RMG Mortgage, Scotiabank, Strive Capital, Tangerine and Think Financial, among others.

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A mortgage broker can compare rates at all of these lenders in minutes. Tangerine and some credit unions are among the few ARM providers you can’t access through a mortgage broker. But, their advertised rates aren’t so hot these days anyhow — unless you live in Manitoba, where credit unions are cutthroat competitive.

Tip #2 — There’s give and take with banks

The two major banks on this list, Scotia and National, sell adjustable rates, but they call them “variable rates,” so don’t be confused. 

Most big banks are known for their higher prepayment penalties on fixed-rate mortgages, but that worry only applies if you convert your floating rate to a fixed rate. 

The most significant benefit of these banks (and MCAP) is their ability to offer an ARM in a readvanceable mortgage. That’s a mortgage with a line of credit linked to it, whereby the credit limit increases as you pay down your mortgage principal. People use such credit for almost anything, including investing, sprouting a new business, or as an emergency fund substitute (if they want to leave their long-term assets untouched in a crunch). 

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Tip #3 — Compounding matters

Most ARM rates compound monthly instead of semi-annually, meaning more out-of-pocket. For example, by taking a $300,000 mortgage to a lender who compounds semi-annually, you’d save roughly $1,300 based on compounding alone — relative to monthly compounding

But before anyone gets too jazzed about compounding intervals, remember that the interest rate and loan terms dictate most of your borrowing cost.

Tip #4 — Some conversion rates are rotten

A conversion rate is the fixed rate you get if you lock in your variable or adjustable rate. Some lenders are non-transparent about those rates. You get what they give you, and you like it. Otherwise, you have to pay a penalty to break the mortgage early. 

If you plan to possibly convert, find a lender that pledges its best rates to people who lock in their ARM to a fixed. 

Tip #5 — Portability has limits

Portability is when you can transfer your ARM to a new property if you move. This saves you from paying a penalty and may also preserve your interest rate discount. The problem is, most ARMs either don’t allow porting at all, or they make you close your old and new homes on the same day (which is very difficult), or you must forgo your rate discount, or they prohibit you from porting and adding more money (a.k.a., a “port and increase”). So, do yourself a favour: chat up your lender or broker about porting policies early on unless you enjoy financial surprises.

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Tip #6 — Stealthy penalties

Most ARMs come with reasonable three-month interest penalties if you break the mortgage before the term ends. But watch out — some lenders pull a fast one, basing those penalties on their prime rate instead of your actual discounted rate. It’s a difference that could leave you up to $750 poorer on a $300,000 mortgage. A few lenders even charge three per cent of the principal to break early, in exchange for a lower rate.

Tip #7 — Cashback

Some lenders offer mortgage customers cash rebates, but many non-bank lenders don’t — or they give you much smaller rebates. 

Others woo you with a free appraisal or “free switch” — which saves money if you’re coming from another lender. ​

Tip #8 — Mind the qualification guidelines

Lender rules vary widely. Some lenders:

  • will not allow mortgages over $1 million
  • keep 30-year amortizations off their menu
  • don’t lend on non-owner occupied properties
  • require high credit scores for their best rates
  • are tighter than a new pair of shoes when it comes to debt ratio limits, making it tougher to qualify.

Unless you’re a strong borrower, you may have to give up a little on the interest rate to find a lender that’ll approve you

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Currently, the lowest advertised ARM rates are prime minus 1.30 per cent (5.90 per cent) if you’re default insured or prime minus 0.56 per cent (6.64 per cent) if the mortgage is uninsured.

With a dash of homework or help from a broker, you can snag an ARM that eases your payment pain when the Bank of Canada hits the rate-cut button. But follow this checklist, and you’ll put extra change in your pocket beyond just the interest savings. 

Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister. 

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