This week alone I have seen first-hand the pitfalls of shopping for a mortgage and going for a “no-frills” option. What does that even mean? Simple. When you get a no-frills mortgage, you’re getting just that: a mortgage with a slightly lower rate, but, less flexibility. And, go figure, this isn’t just an option available with mortgage lenders but also with mortgage banks. Let me give you these three examples.
First was a guy named Gerald* (not his real name, but did you know there’s a DJ named A Guy Named Gerald? If not check him out, he’s chill).
So, Gerald needs to refinance his condo that he owns in order to access equity for a promising investment he wants to make in? You guessed it! Another condo! (Smart guy, this Gerald). 7 years ago he got a mortgage from a bank and thought all would be good when it came time to refinance. Lo-and-behold, Gerald took a “no frills” option which limits his ability to refinance without paying a penalty. And, get this! He already renewed his mortgage one time so this bank had TWO chances to explain to Gerald “hey look, Gerald, you’ve got this no-frills options. Why not renew into a FULL-FEATURED loan?”. Did they? Hell no! So now Gerald HAS TO PAY $4300 in penalty to his bank because they didn’t explain to him what he was signing and didn’t do a proper follow-up when he renewed.
Next we have Larry and Mary* (also not their real names and not the name of an emo-hipster-rock band either. I just made this up, but the story is real). Larry and Mary are shopping for a new house but their condo (which has $200,000 in equity) is all the savings they have. They have been pounding the principal down by pre-paying with all their savings. Smart, right? Yes, except…
When buying a new property they need at least $50,000 in savings to put as a deposit on offer. What’s the best thing to do? I know! Let’s get them a Home Equity Line of Credit (HELOC) and have these funds available on deposit. Also, this will lower their bridge costs when it comes time to moving the mortgage.
But wait! Larry and Mary also took a cheaper-rate-but-crappy-term mortgage. Go figure – they also can’t refinance, add a HELOC, or even move this mortgage unless they pay a penalty. They’re in mortgage prison. Sucks!
And finally we have Hans. Hans called me on Friday at 3pm and stressed to me how stressed out he is about selling and buying, but, more importantly, about his penalty. I looked into his deal and Hans has been doing great. Excellent credit, fantastic income growth, good savings, no debt, and, paying down his millenium falcon condo mortgage quite well. Lots of equity. So we sent his pre-approval to his existing lender for a transfer and again! 3rd time this week! He got burned. Hans took a no-frills mortgage and also is required to pay a penalty of $1550 on $200,000 mortgage because he’s going to move it. Unless Hans wants to wait 3 more years when his mortgage renews, he’s stuck here if he doesn’t want to pay the penalty.
Here’s the thing. NONE of these clients were mine at the beginning. Gerald, Larry & Mary and Hans all came to me after hearing about me from someone. None of these clients would have ever been put into this kind of mortgage because I hate no-frills. IF they put a gun to my head and demanded this kind of mortgage, I would’ve clearly explained it to them AND made them sign a waiver about these options that allegedly would’ve saved them, at best, 20 basis points in mortgage rate. I can assure you if you do the math, these people’s penalties and lack of flexibility was not worth the 20 points because although they paid less in interest over their term, their penalty is far greater than the interest saved.
When shopping for a mortgage, be smart, be diligent, and watch for terms like “limited option” or “no-frills” or “you can’t move this mortgage” or, anything that makes you question the commitment. Call me for a free second opinion and I’ll tell you what you’re signing is either good, or bad. However, the biggest mistake people make is believing they can tell the future, and committing to something long-term with limited features. It’s a bad bet in every respect, don’t make the mistake these (awesome) clients made.