Blended Rates - Do you really win?
A Lender that offers you a blended rate as an alternative to paying the Interest Rate Differential, IRD, to break your mortgage is not doing you a favour. The example below will prove you cannot win!
For example, assume you borrowed $103,324.53 on July 11, 2001 at 7% (semi-annual compounding) with monthly payments of $723.70 based upon an amortization period of 25 years. You signed a term for 5 years, .. meaning the interest rate would remain constant at 7% for the next 60 months.
You are approaching your 24th monthly payment and you notice in the newspapers that 3 year term rates are 5%. You ask your lender the cost to switch to the lower rate of interest. The Lender informs you that the IRD amount is $5,282.85. This IRD would have to be paid along with your 24th payment or added to the balance after your 24th payment. You decide not to pay the IRD. Your lender then offers you a blended interest rate for the remaining 3 years. The graphical summary is shown below. The initial mortgage of $103,324.53 was purposely chosen so that the balance owing after the 24th payment would be exactly $100,000 to make the comparison easy to visualize. The MORTGAGE2 PRO program allows this flexibility. After two years there are 3 paths to follow if you keep your monthly payment the same at $723.70. The green middle path you do nothing and remain inside the current term. The purple path on the right with the IRD added to the $100,000 balance shows the same balance owing at the end of the 36 months, that is $94,071. The yellow path on the left, the lender allowed you to switch to the 5% without paying the IRD.
If the monthly payments remain at $723.70 for the next 36 months and you don’t pay the IRD a rate between 5% and 7% will save you from $6,126 to $0 (that is 94,071 – 87,945).
If the Lender allows your monthly payments to be less than $723.70 there are many blended rates you could be quoted. How would you know if your were “saving” interest or what your balance would be after the next 36 months without an amortization schedule? Obviously your lender is not going to give you a blended rate of 5% with the same monthly payments (yellow path).