Tips, Advice, and Explanations from a Vancouver Mortgage Broker  

Posts Tagged ‘construction’

How Are Mortgage Penalties Calculated?

Sunday, April 25th, 2010

I’m getting lots of questions about why bank penalties have fallen in the last three weeks. This blog explains the calculation methodology behind it:

Transcript of Video Blog:

Hi, everybody. It’s Rowan Smith from the Mortgage Centre. I wanted to address penalties, and interest rate differentials, and three month interest penalties and how it all works today in this blog.
I’m getting a lot of inquiries about it. There’s some confusion as to why rates have gone up and penalties have gone down. Well, let’s look at the standard mortgage terms.

For variable rates mortgages, most institutions, the way that it’s going to work is if you break the term at some point during any time; now most variables are five year terms, but some of them are three years.

That means that during that period of time, your discount or your premium on your rate will not change. For example, if your rate was prime rate plus a quarter, for five years you would always be prime plus a quarter regardless of where prime went. Up or down, you would follow it with a quarter percent.

You’re guaranteed that, so should banks go with prime plus a half or prime plus one, you’re still guaranteed to retain the prime plus a quarter throughout that five year term.

In exchange for that security, if you break that term, that five-year term, to sell your house, or you need to refinance, take equity out and end up doing it with a different lender, you’re going to pay a three month interest penalty.

That said, it’s a non negotiable. It’s going to happen at every single institution. However, the three-month interest penalty is the only one that will apply to a variable rate mortgage. In the event that you’ve got a fixed rate mortgage, it will be the greater of three months’ interest or the interest-rate differential.

Interest rate differential is a complicated formula that essentially looks at how much time is left in your term, what rate you’re paying now, what rate the bank could get on money now, and they charge you that difference. That’s a simplification, or perhaps an oversimplification of it.

But if you visualize being at six percent, and let’s say rates went down to the 3.69 they were at and you wanted to get that rate, that bank would be giving up on six percent for the remainder of your five year term and letting you out into the lower term.

So they’re going to look at their loss/profit and are basically going to charge you that amount or three months’ interest, whichever is greater.

You can guarantee that in cases where rates have gone down, your penalty is going to be dramatically larger under the interest-rate differential. Now how far down? It depends. It’s a complicated formula.

How much time is left in your term? If you’re within the last year, it’s generally only ever three months’ interest. There are a lot of different variations in how these penalties can be calculated from bank to bank to bank.

So if you’re looking at your penalty, not quite sure if the penalty is worth paying it to get the new lower rates, give me a call and I can walk through the math with you on it and make sure that you’re making a correct decision.

Also, if you’re looking at that penalty and wondering why did the penalty go down from last month when I had a quote, it’s because rates came up. That means that the bank could get a greater rate from money loaned at the same point at time.

So if you were three years into a five year term, there are two years left. The bank will compare their profit and loss of what they would get on a two-year mortgage.

Imagine, for example, that rates have gone in two years from, let me grab a number here, 2.25 to 2.9. If you were previously paying five percent, that spread, the difference between what they could be getting and what they are getting, got smaller, thus your interest-rate differential penalty will be smaller.

As you can see, there’s quite a bit to penalty calculation. If you have any questions, give me a call. For the Mortgage Centre, I’m Rowan Smith.

Construction Mortgages – An Overview

Sunday, April 11th, 2010

We get inquiries on construction mortgages constantly. This video offers a high level program overview – and covers the essentials if you are thinking of buying a lot and building:

Video Blog Transcription:
Hi everybody, its Rowan Smith from the Mortgage Centre. I want to talk to you today about construction mortgages.

A lot of people are looking at some raw land, lots available in the area. They are thinking to themselves it would be nice if they could buy the property, build the home they have always wanted, and put it on there.

They are familiar with hearing the five percent down rule — that that is the minimum down payment. They come and approach me and they want to get approval in those cases.

It is usually not going to happen. The person who is putting the five percent down, first off, five percent of what? Five percent of the lot, five percent of the lot with the home, the end value, or five percent of the lot plus the construction costs? It depends what they are trying to do.

Generally, if you are trying to do high ratio construction, that is anything where you are financing more than 80 percent of the cost of the property, you have to have enough income to service not only the debt, but also your living expenses during the period of time.

Most people are building the homes for whatever reasons. Whether it is tax efficient accounting, or whatever, they rarely seem to have that income if they are trying to build the property. My experience is that most construction mortgages you are going to need 35 percent of the end value in order for you to really get that construction deal done.

So if the home is $1 million bucks, you can look at having to put $350,000 of your own money into the deal. Now the way it works is you don’t get to borrow 100, 200, 300, 400, $650,000 and then put your money in. It is not the way it works. The bank will always want your dollars in first.

What is going to happen is they are going to finance, say 65 percent, or 70 percent of the land. They will advance dollars at that point. You will put up some of your money. Then, they will say OK, we have advanced… I am going to grab a number here.

Lets say the home is $1 million bucks and the lot is $200,000. So they are going to give you 65 percent of $200,000 to start with, so $130,000. You take that money, you have to come up with the rest. So you are putting in the 70 of the $200,000 lot.

Now what happens? You go and start your construction. The bank does not start advancing you the balance of the $650,000 that they are going to lend you. They make you put your money in first. Those initial construction costs are going to be yours, and you are going to cover them with your dollars.

Once you have the house to certain stages, at that point the bank will start to advance you money. So at drywall, or at lockup rather is usually the first stage, it is about 60 percent. Then there is at drywall, and then usually again at the end when the property is actually completed.

It varies from institution to institution and what percentage point they are going to make you complete the home. They will have one of their appraisers come through and just kind of qualify and say, “Yes, this much work is done. The remaining costs to complete is x amount of dollars.” The bank will then lend you release money at that point.

You usually have to be well enough financed to come up with cash up front so that you can afford the construction costs and the labor trades, then get the money owed at the end of the day. If you are thinking you are going to borrow the whole amount for construction, it is not going to happen.

If you have anybody that is looking for construction loans I can help kind of point them in the right direction. Let them know if their estimates of costs and their budget, and especially their capital usage and when it is going to be required is reasonable.

Give me a call. I am Rowan Smith for the Mortgage Centre.