Question from Kristina in Toronto: I own a condo and have a variable mortgage with one year left on my term. My partner also owns a condo and has a fixed mortgage with a similar length left on his term. We are looking to buy a house together. What are our options for the mortgage? Do we need to break one or both mortgages?
Dear Kristina,
Congratulations on taking this next housing step with your partner. Having two properties to use as capital will certainly give you a leg up on your next home purchase, as the equity you and your partner have built gives you some options. There are a few different ways you can approach your next mortgage, depending on your intent and the cash you’ll need.
Assuming you require the proceeds from both property sales to fund your new house purchase, you’ll need to break at least one of your two mortgages. The first step here is to see which will cost less to do so, based on the penalty – and it’s almost always cheaper to break a variable-rate mortgage, as you’ll be charged just three months’ worth of interest.
Fixed-rate mortgages, meanwhile, are subject to a more complicated penalty based on an interest rate differential (IRD). This calculates the difference between the mortgage’s original interest rate and the rate the lender is charging today for the same term. This essentially compensates the lender for the lost profit they would have otherwise made on your mortgage if you hadn’t ended it early.
Unless you have very little time left in your term, the IRD will almost always be more than three months’ worth of interest, especially since mortgage rates have increased significantly over the past five years.
However, if the IRD is less than three months’ worth, your lender will go with the higher of the two – so it’s important to crunch the numbers for the penalties of both mortgages before making a decision. Your mortgage broker can do this – or you can use an online mortgage penalty calculator.
A benefit to keeping your partner’s fixed-rate mortgage over your variable is that they may have the ability to port the mortgage, which can save money depending on their original interest rate. Variable-rate mortgages tend not to be portable, as new lenders aren’t keen to take on a loan where the rate could fluctuate lower than what they could otherwise charge.
Now, unless the mortgage amount for your new home will be exactly the same as your partner’s mortgage balance – known as a straight port – their existing rate will go through a “blend and extend,” meaning it’s combined with a current rate offered by the lender and increased from the remaining one year to another term of your choosing.
This new blended rate won’t be as low as when your partner originally got it – again, assuming they took it out during the rock-bottom lockdown era – but it can take the edge off, as the rate and terms for the original mortgage amount will come over, and just the remainder of the new purchase will be subject to today’s interest rates.
Again, you need to crunch the numbers here to see if the savings from the ported and blended rate outweigh just taking out a new fixed-rate mortgage altogether from a different lender and the associated penalty to break the mortgage.
Given that you’re both coming into this new mortgage with greater equity in hand, it’s possible you’ll qualify for a more competitive rate this way – but it’s worth exploring both options.
One last possibility: What if you didn’t have to break either mortgage? If you and your partner have enough capital between the two of you, either from savings or the sale of one of your properties, you could choose to rent out your previous home instead.
In this scenario, the potential income from your rental – determined via market appraisals or a new lease agreement – will be factored into your new mortgage qualification. Your lender would also assess the liability of you owning a rental via the PITH (payment, interest, taxes and heat) calculation to confirm you can carry both properties.
If the numbers check out, you could continue building equity in multiple homes, with rental payments potentially offsetting mortgage costs.
While there are other considerations that come with being a small landlord – such as maintenance, tenant relations and insurance – it’s financial food for thought, especially if you’re already well-versed in the risks of carrying a variable-rate mortgage.
Of course, you’d have to make sure you don’t stretch yourself too thin financially – there’s nothing worse than being house poor at a time when the outlook for the economy and the housing market is questionable.
Do you have a mortgage question? If so, submit it here and we could answer it in an upcoming column.
Penelope Graham is the head of content at Ratehub.ca.
