What Are Blended Mortgages?
With interest rates at a record low, and more and more homebuyers looking to take advantage of the equity in their home, many consider blended mortgages. Blended mortgages are yet another tool that homeowners can access existing equity in their property for re-investment with. To access this equity, one would need to refinance their existing mortgage.
Refinancing a mortgage is a process but provides the mortgage holder with three unique options. You can break your mortgage and re-sign a new one. You can utilize a home equity line of credit or a second mortgage or get a blended mortgage.
Breaking your mortgage
Generally, there are two reasons for breaking your mortgage. The first is to gain access to a lump sum of equity in your home. The second is to obtain a lower mortgage rate. When you break your mortgage, you are paying off your existing mortgage and re-signing a new mortgage. Naturally, lenders charge a fee to break your mortgage, which will depend on your mortgage type, the length of time left on your mortgage, and your current mortgage rate.
If you have a fixed rate mortgage, the standard prepayment penalty is three months interest or the interest rate differential (IRD), whichever is greater. The interest rate differential is based on the mortgage amount you are prepaying and the interest rate that equals the difference between your existing mortgage and the interest rate on the new mortgage. You can use this calculator to plug in your numbers to see your specific IRD to prepay your existing mortgage.
If you have a variable rate mortgage, the standard prepayment penalty is three months interest.
Breaking your mortgage can be an expensive endeavour and might not be the right vehicle to use, depending on your current financial circumstances. Depending on your current mortgage rate, penalties, and fees, breaking your mortgage is not always the best choice. Thus, there are two other options for mortgage refinancing to access the equity in your home.
Home equity line of credit (HELOC)
A home equity line of credit is yet another vehicle for homeowners to access funds. To qualify for a HELOC, you have to have at least 20% equity in your home and have a good credit score. For those who do not have that you can access a second mortgage from a private lender. We detail the home equity line of credit and second mortgages on our second mortgage page.
Blend and extend mortgage
A blended mortgage presents an opportunity to take advantage of their home equity and the low interest rates without having to pay the expensive and often limiting prepayment penalties that come with breaking your mortgage. A blended mortgage allows a borrower to blend their existing mortgage rate with a current interest rate of a new mortgage. This blended rate then allows a borrower to secure a hopefully lower rate, and then extend. You may also see this referred to as a blend and extend mortgage or blend to term mortgage. So, let us jump into some more details about blended mortgages, why they are a useful tool and what you can expect from this vehicle moving forward.
To provide you with an example, here are some numbers.
You have a current rate of 4%, and new mortgages are being offered at 2%. You can refinance your existing term for a blended mortgage and secure a new term with a new blended rate. This new rate will be somewhere between 4% and 2% and depend on a calculation done by the lender. Typically, borrowers can expect to drop a whole percentage point or two when blending, but again, it will depend on your specific financial circumstance.
Why choose blended over refinancing besides the interest rate?
Blended mortgages are a great tool and often the preferred refinancing option due to two specific reasons. First, the lower interest rate if the rates have dropped since you signed your mortgage. Second, the lack of any fees or penalties for blending your remaining mortgage. Unlike other refinancing tools, you do not need to break your mortgage and avoid paying prepayment fees or additional costs associated with breaking the mortgage. Thus, blended mortgages have been one of the most popular options for people when the Bank of Canada prime rate is low and interest rates have dropped.
Who carries blended mortgages?
Lenders are not going to advertise if they carry blended mortgages. It is not in their best interest, and thus you will need to take a look and search out lenders who offer these services. The reason for this is quite simple. Lenders are not going to publicize or advertise that you could be paying an excessive amount of interest on your loan. There is no gain for a lender; in fact, it is a net loss as they will end up losing money over the mortgage term.
So, saying that, many leading lenders in Canada do offer blended mortgages. Unlike second mortgages or other tools that you may have heard of, blended mortgages are offered at the big five banks, credit unions and other primary and small lenders. You will typically find three specific types: the blend to term, the blend and increase and the blend and extend. We will detail these three mortgage types and how they can help you save money and get a lower interest rate.
Blend to Term
A blend to term mortgage is similar to a blend and extend but does not extend your mortgage term past your current mortgage term. This means that your new mortgage contract will end when your original term was scheduled to end. Thus, if you are in year four of a five year fixed mortgage, your mortgage will still end in a year.
This type of mortgage is handy for those looking to re-sign a mortgage in the near term but pay a higher interest rate than the current rate. During the COVID-19 pandemic, with low interest rates, many borrowers looked to capitalize on this style of blended mortgage to secure a lower rate while maintaining their current expiry date. Thus, this mortgage type would let them re-sign at a lower interest rate while not extending their mortgage expiry by years with a higher blended rate.
It is possible to switch to a blend to term mortgage for the sole reason to take advantage of low mortgage rates. You do not need to pull any extra money from the lender, and you will not pay a high fee to complete the process. However, if you are in this situation, a lender may entice you to sign a blend and extend mortgage with a slightly higher rate than the current mortgage rate. But remember, the advantage of a blend to term is to lower your rate and not extend your term so that you can lock in a lower rate once your term does expire. The bank will want to extend you, but if you are not taking any extra money, stick to your guns and look for a blend to term rate that works for your situation.
Blend and Increase
Blended mortgages are a flexible tool and can be used to borrow money while also lowering your overall mortgage rate. A blend and increase mortgage allow you to borrow additional funds on top of your original mortgage amount. The combined amount is then tied to your blended rate. These blended mortgages blend and increase as you are blending your interest rate while also increasing your existing mortgage.
This mortgage type is excellent for those looking to reinvest into a property or home renovations, pay for college or higher education, or even consolidate some existing debt into a single monthly payment. Whether you are looking for extra money to help out a loved one or reinvest, these mortgages offer an option that does not require a HELOC nor has a steep prepayment penalty.
This mortgage type is a good option for both borrowers and lenders looking to increase the amount of liquid capital they have. It means you can drop the overall mortgage rate you are paying while not having to balance two separate mortgages for a borrower. The lender increases the amount borrowed and can expect a more significant interest return, even at a slightly lower rate. Both parties get something out of the deal, and that is rare these days.
Blend and Extend Mortgage
One of the most common options in the industry for blended mortgages is the blend and extend option. As it sounds, the blend and extend mortgage blends your existing interest rate with a new rate and then extends your term back to its full length. This small change means that if you are in year 3 of a 5-year term, you would be signing up for another five years at this blended rate.
The blend and extend option is designed for people who are currently in higher mortgage rates to have a budget-friendly option without much upheaval or anything else. These mortgages allow for people to plan long-term and lock in a reasonable rate for multiple years. For lenders, these mortgages are outstanding as they extend the term while still having a borrower sign for a slightly higher interest rate than the advertised rate.
It should also be noted that borrowers can blend and increase and blend and extend at the same time. It is common practice in the industry and allows you to keep your monthly payment a little lower while still receiving some equity that you can reinvest or use to help with debt or other uses.
It is important to note, if you end up taking out equity and adding to your mortgage during a blend and extend mortgage negotiation, your rate will move towards market rate. This is because the lender will make more money, as a lower interest rate on $300,000 borrowed makes the lender more money than a slightly higher blended rate on $200,000 borrowed.
What is the better choice?
This is a tricky question to answer, as every person’s situation is going to be a little different. Here are three hypothetical situations where each type of loan is the perfect fit.