Early renewal

Borrowers whose long-term mortgages are coming up for renewal in a year's time, always fear another round of rate hikes before maturity. That's especially true when interest rates go on a roller-coaster ride the year before maturity. If rates bottom out during that time and then escalate, they lose out getting the lowest possible rate. And with renewal notices sent out as few as 15 days before the end of the existing mortgage term, the rate they pay is little more than the luck of the draw, depending on when the mortgage comes due.

To the rescue: the "early renewal" option (the long-term cousin of "convertibility"), another essential feature for anyone booking a long-term mortgage. Again, though, it's only available at a handful of lenders.

With early renewal, instead of being able to renew their mortgage only at the end of the last year of the mortgage term, they can renew their mortgage at any time during the course of the last year of the term. By allowing the borrowers to renew their mortgage with the same lender when rates are at their lowest during that last year, early renewal helps eliminate much of the uncertainty about interest rates.

In a normal renewal, the lender sends out the renewal notice shortly before maturity. Not so with early renewal; instead, the borrowers themselves trigger the renewal process.

What's the cost to borrowers? Like with convertibility, it's the ability to switch lenders if borrowers decide to renew before the mortgage comes due. Waiting until full term allows the borrowers to change lenders at the end. Early renewal means staying put, but as with convertibility, that's a price many borrowers are prepared to pay, considering the enormous flexibility early renewal provides.

But there's a second cost borrowers must face when early renewing, this one out-of-pocket. Lenders want to be compensated for allowing borrowers to break the old mortgage commitment during the last year and replace it with a new one. The penalty the borrowers must pay is the present value of the difference in the interest rates (contractual vs. current) on the outstanding principal for the balance of the mortgage term -in other words, the interest rate differential or IRD. That's the cost to the lender of renewing the mortgage early; that's the cost borrowers must bear for the privilege of renewing before maturity.

Remember that it's up to the borrowers to initiate an early renewal. Nothing will happen unless the borrowers put the early renewal wheels in motion.

Having an early renewal feature means borrowers must become interest rate watchers during the last year of the mortgage term. More importantly, this feature provides them with the flexibility to capitalize on lower rates during that time, instead of simply watching from the sidelines as the interest rate parade goes by.

Many lenders claim to offer early renewal but fail to say so in writing in their mortgage documents. How can any borrower rely on such a critical clause several years from now, if the details aren't spelled out in black and white? Protect yourself. If early renewal is important, make sure it's right in the mortgage before you put pen to paper. If needed, have the clause appear in a side agreement or a letter.

Despite what many people think, mortgages are not automatically renewable when they mature. In fact, the opposite is true: when a mortgage comes due, technically it must be repaid in full. Lenders are under no legal obligation to renew a mortgage on maturity, unless a renewal clause appears in the mortgage. (Despite this, many institutional lenders will offer renewals to good-quality borrowers on maturity.) Early renewal is such a clause. It's the lender's guarantee that the mortgage will be renewed, if the borrower starts the renewal process before the full term has expired.

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