The Hybrid Mortgage: Diversifying Your Rate Exposure
The fixed versus variable rate debate is a classic in Canadian mortgage financing. The hybrid mortgage, also known as a combined or split mortgage, offers an elegant solution for borrowers who do not want to put all their eggs in one basket. By dividing the mortgage into two distinct portions, each with its own rate type, this approach mitigates risk while preserving savings potential.
Structure and Mechanics of the Hybrid Mortgage
The hybrid mortgage divides the total financing amount into two tranches. The first tranche carries a fixed rate for the duration of the term, providing payment predictability. The second tranche carries a variable rate indexed to the lender's prime rate, offering the potential to pay less interest if rates remain stable or decrease. Both tranches share the same term, the same amortization period, and are secured by the same property.
- Hybrid mortgage (split mortgage)
- A mortgage divided into two portions: one at a fixed rate and the other at a variable rate. Both portions share the same term and the same property as collateral, but each is subject to the conditions specific to its rate type, including prepayment penalty terms.
Common Splits and Strategies
- 50% fixed / 50% variable: a balanced split offering equal exposure to both rate types. A popular option for borrowers who want a simple compromise.
- 70% fixed / 30% variable: a conservative split that prioritizes stability while retaining a variable portion to benefit from potential rate decreases.
- 30% fixed / 70% variable: an aggressive split that maximizes the savings potential of the variable while keeping a fixed cushion for predictability.
- Custom split: some lenders allow borrowers to freely choose the percentage allocated to each portion, in 10% increments.
Implications for the Prepayment Penalty
One of the lesser-known advantages of a hybrid mortgage relates to the prepayment penalty. If the borrower decides to break the mortgage before term, each portion is calculated according to the rules specific to its rate type. The fixed portion is subject to the greater of three months' interest and the IRD, while the variable portion is limited to three months' interest. As a result, the total penalty on a hybrid mortgage is often significantly lower than on a fully fixed-rate mortgage, providing greater flexibility for the borrower.
Key Points to Verify Before Choosing a Hybrid Mortgage
- Loan portability: Verify whether both portions of the mortgage are transferable to a new lender at renewal. Some lenders limit the portability of hybrid mortgages, which could reduce your negotiating power.
- Prepayment privilege conditions: Ensure you clearly understand how prepayment privileges apply to each portion. The annual permitted percentage (typically 10% to 20% of the original balance) may apply globally or per portion.
- Variable portion conversion: Ask whether the variable portion can be converted to a fixed rate mid-term without penalty. This conversion option provides additional protection if rates increase significantly.