1.99% Interest Rate! Wow, that’s low! But WAIT! Is it really as good as it sounds? Sadly, it is not!

A major financial institution recently cut its three-year variable mortgage interest rate to prime minus 1.01% (prime is 3.00%. Prime minus 1.01% = 1.99%). It’s the lowest variable rate we’ve seen in quite a long time. That’s pretty amazing, at first glance. Dig a little deeper and you’ll find strings attached that lock you in and limit your ability to draw your equity, thereby effectively inhibiting your ability to, say, use the equity funds to renovate and further increase the value of your property .

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Let me nutshell equity for you before breaking down what we found when we dug deeper into the 1.99% offering.Homeowners acquire equity in their home from a few sources. They purchase equity with their downpayment, and the principal portion of any payments they make against their mortgage. They also benefit from a gain in equity when the value of the property increases. So, when your property value increases over time, most lenders allow you to draw from that equity by refinancing your mortgage. Refinancing refers to the replacement of the existing debt obligation (in this case, your mortgage) with another debt obligation under different terms (a new mortgage). In fact, there are many reasons why you may want to refinance your mortgage. You may be looking to lower your mortgage payment, adjust the length of your mortgage; switch from an ARM (Adjustable Rate Mortgage) to a fixed rate mortgage or as mentioned above, to tap into your home’s equity. The 1.99% rate/product (sometimes called a ‘No Frills’ mortgage), will not allow you to do any of this. Here is what we found when we looked closer at the 1.99% product offering:

  1. If you don’t have a downpayment of at least 20% you must effectively qualify for a mortgage at a rate of 4.99! They fail to mention that.
  2. There are RESTRICTIONS around the customer’s ability to break the mortgage before the term is up (which is 36 month’s). For instance, you’re NOT allowed to refinance; you’re only allowed to remove yourself from the mortgage if you SELL THE PROPERTY. Boo. So if you want to refinance to take advantage of equity that has built up in your home (for repairs, upgrades, renovation, vacation etc.), you can’t OR if you can, you have to stay with the same financial institution and then you’re subject to their rates. Think about this for a moment. Will they offer you the lowest rate? Likely not, they’re a major bank and what would be their motivation? You can’t break the mortgage and go elsewhere, so why wouldn’t they charge you more?
  3. The company doesn’t have the infrastructure set up to handle a massive influx of customers. Someone called about an $800,000 mortgage and they said “We’ll get back to you in two to three days”. Need I say more on this?
  4. This low rate is being offered up so that they can cross sell their investment products. So, they get you in the door with an attractive interest rate of 1.99% and then BoOm, you find out that you have to buy into their investment products or move your existing investments to them. See point 5 below.
  5. They get the opportunity to wrap you up and cross-sell their mutual funds and upon renewal you’ll likely pay an extra half a per cent for a five-year.
  6. Their five-year posted rate is currently at 3.4%, which is higher than what the market-leading banks are offering.
  7. On a positive note, the offer does come with the ability to double up monthly payments, or pay a 15% lump sum once a year. In real dollar terms, it could knock a lot of money off a mortgage payment, at least over the short term. A standard 25-year $500,000 mortgage at a five-year rate of 2.99% for example, works out to $2,357.82 a month. That mortgage under the financial institutions new terms would be $2,111.36 a month – savings of $246.46 monthly, at least for the first three years, and as long as the variable rate doesn’t increase. On that note, you should know that there are plenty of lenders that allow you to make prepayments of up to 20% per year without any other costly strings attached (i.e. you don’t have to buy into other products and you DO have the option to refinance with the same lender or another lender; you’re not locked in and you don’t have to sell your home).

Seemingly, they are trying to break the psychological barrier of 2% to generate interest just in time for the peak spring buying season. It’s an interesting move but it’s a move that will not save you money; in fact, it’ll likely cost you more in the end.

How do you feel about this?