Wish you could predict the future? While choosing a fixed rate is generally a safe and sensible move when getting a mortgage, we understand how frustrating it can be to wish that you had made a different decision. Particularly when interest rates drop.
If you’re currently in this exact situation and wondering whether refinancing your mortgage is a good option, we have a different suggestion for you, the blended mortgage.
Key Points
- A blended mortgage combines your existing mortgage rate with a lender’s current rate, resulting in a new rate somewhere between the two.
- There are three types of blended mortgages: blend to increase, blend and extend, and blend to term.
- Blended mortgages can be advantageous over refinancing as it helps you avoid penalty fees.
What Is A Blended Mortgage?
A blended mortgage is when you combine your current mortgage interest rate with the rate from a new mortgage. The new rate is a blend of the two, which is somewhere between them.
A blended mortgage offers a way to take advantage of a better rate or to gain access to your equity without having to pay penalty fees for breaking your mortgage contract early.
How Can I Get A Blended Mortgage?
To get a blended mortgage, you’ll need to ask your bank or mortgage lender if they offer it and if you’re eligible. Here are the blended mortgage options available:
The Blend To Increase
The blend to increase option allows you to borrow more money. In this case, the additional money borrowed will be tacked on to your current mortgage. The total mortgage amount will be charged at the blended rate.
The Blend And Extend
The blend and extend option means you’ll blend your existing interest rate with the interest rate your lender currently offers to get a new interest rate somewhere in between. Then, your lender will give you a new term by extending it back to its full length.
For example, let’s say you’re currently two years into a 5-year fixed-rate term with an interest rate of 5%. Now, your lender is offering a rate of 3% to new borrowers. In this case, you’ll receive a new blended interest rate that falls somewhere between 5% and 3% and have your term extended back to 5 years.
The Blend To Term
The blend to term is similar to the blend and extend. In this case, you’ll receive a new blended interest rate, but your term won’t be extended. Your new mortgage contract will end when your original term is supposed to end.
So, if you’re three years into a 5-year mortgage, for instance, your new blended rate will only be locked in for the next two years. But it won’t be extended to a full term.
Which Is A Better Choice?
As interest rates are so hard to predict, it can be difficult to say for certain which option is better. Here are a few things to consider:
Blend to extend. This option allows you to borrow more than your current mortgage amount and access additional funds to cover a big expense.
Blend to term. This option will allow you to renegotiate your interest rate within a shorter time frame if your term ends and interest rates have remained low. As such, you could receive an even lower rate and therefore save even more money.
Blend and extend. This option provides more stability than the blend to term. You’ll know exactly what your interest rate is and that you can afford your mortgage for the next five years.
Both options have their benefits. It’s up to you to decide what’s more important to you and your finances.
Choosing A Blended Mortgage Over Refinancing
Aside from gaining access to your equity or taking advantage of a lower interest rate, the main reason to choose a blended mortgage over traditional refinancing is to avoid the fees associated with breaking a mortgage contract. These fees can often be upwards of $10,000, depending on several factors, such as:
- The amount you want to pay off
- The number of months left until the end of your term
- The interest rate
How Much Can You Save In Early Repayment Penalty Fees?
When you break a mortgage contract, your lender will charge you fees based on whichever one of the following two calculations is greater: 3 months interest or the Interest Rate Differential (IRD).
Three Months Interest
If three months’ interest is a larger amount than the IRD, you’ll be charged that amount to break your mortgage contract. But, here’s the issue: most borrowers looking to refinance their mortgage almost always trigger the IRD, and therefore end up paying quite a lot of money to get a slightly lower interest rate. Typically, the cost of the IRD negates the change in interest rate and therefore breaking their mortgage contract does not make sense.
Side note: There is a rare “sweet spot” that will help you avoid triggering the IRD. If you can find that spot (which your mortgage specialist will help you with), you’ll be charged three months interest to break your mortgage contract instead of the IRD. If this is the case for your mortgage, it could be financially beneficial to break your contract.
Interest Rate Differential (IRD)
As we said before, it’s more likely that the IRD will be greater than three months’ interest. The IRD is calculated based on the difference between your existing interest rate and the rate your lender could charge if they lend the remainder of your mortgage for the rest of the term.
The IRD ensures borrowers aren’t constantly breaking and renegotiating their mortgages every time the interest rates go down. After all, lenders make money off of mortgages, and the IRD protects the lender from loss of profit.
Pros And Cons Of A Blended Mortgage
There are perks and drawbacks to a blended mortgage that you should consider before choosing this option:
Pros
- Avoid prepayment penalty fees. As mentioned, you can avoid getting slapped with hefty penalty fees for breaking your mortgage early when you choose a blended mortgage.
- Get a lower interest rate. Another big reason to consider a blended mortgage is if you can secure a lower rate than your original rate. This can save you a ton of money over the loan term.
- Access equity. You can gain access to some of your home equity when you refinance using a blended mortgage, then use the funds to cover big expenses, like home renovations or consolidating high-interest debt.
Cons
- Can’t be transferred to another home. If you move, you can’t take your blended mortgage with you. Blended rate mortgages can’t be transferred to another property if you move, and can only be created at the time of moving. If you plan to sell soon, consider another option besides a blended mortgage.
- You may spend more than the prepayment penalties. In some cases, opting for a HELOC or home equity loan might make more financial sense compared to the money you could avoid spending on early prepayment penalty fees. This depends on your goals and what’s happening in the current market.
When Does A Blended Mortgage Make Sense?
There are some cases where a blended mortgage might be worthwhile for you:
A blend and increase mortgage may be best if you need access to your home equity to cover a big expense or to consolidate debt. Just keep in mind that a home equity loan or HELOC may be a better option if the current rates are higher compared to your current rate.
A blend and extend mortgage may be best if you expect interest rates to increase shortly and your mortgage term is coming due. Depending on the exact situation, you may consider restarting your 5-year term with a slightly higher rate if it’s lower than a new interest rate.
A blend to term mortgage may be best if you don’t want to lock into a blended rate for the entire 5-year term and prefer flexibility with other options.
Final Thoughts
When it comes to breaking mortgage contracts and mortgage refinancing, you need to speak with a mortgage specialist. Deciding whether to opt for a blended mortgage — or another financing option — will take some time and planning and a few calculations. So, if you aren’t confident in figuring it out or are just interested in a second opinion, a mortgage specialist can help.
