Hybrid mortgages – also known as 50/50 mortgage products – include an equal mix of fixed-rate and variable-rate components within your single five-year mortgage. This means you get the best of both worlds – the security of fixed repayments with the flexibility of a variable rate. (Use our compare home loans feature to learn more about fixed and variable loans)
Although there was a time in recent years when mortgage experts considered a variable-rate mortgage as the obvious choice to save mortgage consumers money over the long term, with fixed rates remaining near historic lows, a 50/50 mortgage may be a great alternative for your first home purchase.
In essence, since it’s extremely difficult to accurately predict rates over the long term, a 50/50 mortgage offers interest rate diversification, which can help reduce your level of risk. And even if you can qualify for a fully variable mortgage, experts agree that unless the spread between fixed and variable rates is at least two per cent, it’s often not worth your while because the savings are not worth the risks involved.
This is the kind of rate environment we’ve been in as of late because fixed rates are hovering at historically low levels. But with variable rates starting to fall in price again, this is perfect timing for the release of a product such as the 50/50 mortgage.
If you opt for a 50/50 mortgage product, half of your mortgage is locked into a five-year fixed rate and half is set at a five-year variable rate. You can lock in your variable-rate portion at any time without paying a penalty. As well, each portion of the 50/50 mortgage operates independently – like two separate mortgages – yet the product is registered as only one collateral charge.
Who does it work for?
The ideal candidate for a 50/50 mortgage could include three potential first-time buyer scenarios:
1. The knowledgeable person who likes to watch interest rates and the economic market
2. The risk-taker who still likes the security associated with a fixed product; and
3. The person who may not know too much about the market, interest rate fluctuation or the bond market, but wants to capture some variable and some fixed to diversify their mortgage.
But there are several reasons why it may be too risky for a first-time homebuyer to opt for a fully variable mortgage.
First, rates could go higher, causing their payment to rise to an unaffordable level.
Another risk occurs if a first-time buyer doesn’t look at rates and keeps their payment as low as possible, and the amortization (length of time it takes to pay off the mortgage) increases to 40 or 45 years because the rates have risen but the payments have not. A typical amortization is 25 years, although you can start out with a mortgage spanning up to 35 years. So, if your mortgage takes 40 or 45 years to pay off, you’re going to be paying thousands of dollars extra in interest payments over the life of your mortgage.
And if you opt for a fully variable product and then decide to lock into a fixed because rates are rising, you often end up locking into a much higher rate or a fixed product that is not discounted – meaning that you can end up with a posted rate, which is never the lowest option you can negotiate with a lender.
As well, you will pay a penalty if you decide to cash out the mortgage (once you have switched to a fixed rate). This penalty is based on the greater of an interest rate differential (IRD) or three months’ interest penalties instead of just the standard three-month interest penalty on a variable. These penalties can be extremely large – as high as $31,000 on a $381,000 mortgage.
IRD, in this case, is the difference between the fixed rate at the time of lock in and the rate that the lender can lend out the money again in a new mortgage today, based on the length of the outstanding mortgage term. The lender has some discretion as to what rate they can lend the money out at today – some will take the discounted rate while others will take the posted rate.
For instance, suppose you have a mortgage balance of $200,000. The rate on that mortgage is seven per cent and you have two years left on your current mortgage. Your lender’s two-year posted rate for a new mortgage is five per cent. To calculate the penalty, take $200,000 x (7% - 5%) x 2 years = $8,000. Three months’ interest on this mortgage at seven per cent would be $3,500. As you can see, if you have to pay an IRD penalty, you’d be paying well over double the penalty compared to a straight three months’ interest charge.
Although all of this sounds incredibly complicated, if you enlist the services of an experienced mortgage professional, they will be able to explain everything in layman’s terms with examples specific to your unique needs, and list the pros and cons of each type of mortgage they’re suggesting you opt for.
Lenders offering combined products
Merix Financial was the first lender to come out with a straight 50/50 product earlier this year called the 50/50 Wise Mortgage. White label mortgage products have since been developed for various national mortgage brokerages, including Dominion Lending Centres’ 50/50 Balanced Mortgage. White label products are provided by lenders but branded by national mortgage brokerages for their exclusive use.
Aside from a straight 50/50 mortgage, however, there are other products available where you can also have a combined variable and fixed mortgage – but not necessarily have to split it 50/50.
The Scotia STEP mortgage, for instance, enables a borrower to opt for a partial variable and a partial fixed mortgage. In fact, it can actually go one step further and enable you to split your mortgage three ways using a mixture of terms (such as one, three or five years, etc) and fixed and/or variable rates. For example, you can place a portion of the mortgage in a five-year fixed, some in a five-year variable and the remainder in a one-year fixed.
The STEP can also include a home equity line of credit (HELOC) product that can also be split into three portions to track both personal and investment expenditures separately – where all three could be personal, all three could be for investment purposes, or any other possible mix between the two uses to a maximum of three different components. You must qualify for a HELOC product, however, so if you don’t make a substantial down payment that enables you to already have equity built up in your home, this is not a viable option.
The difference between a straight line of credit (LOC) and a HELOC is that the HELOC uses your home as collateral on the loan. As a result, the interest charged on a HELOC is considerably lower that what you’d pay for a LOC.
As the 50/50 option is a fairly new offering, according to a recent study by the Canadian Association of Accredited Mortgage Professionals (CAAMP), five per cent of Canadian mortgage holders have 50/50 mortgages compared to 28 per cent with variable-rate mortgages and 68 per cent with fixed-rate mortgages. But many experts believe the 50/50 mortgage is quickly gaining momentum.
While most people opt for a fixed-rate mortgage because they consider it the “safer” choice, it’s well worth your time to fully discuss all of your options with an experienced mortgage professional. The best place to start is with a referral from family, friends, peers or coworkers so you know you’re working with someone others close to you already trust.
Cindy Freiman is Director of Communications & Public Relations for national mortgage brokerage and leasing firm Dominion Lending Centres. She can be reached at: 289-240-6322; email@example.com
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