Interest Rate Blending

Over the last few weeks, a recovering economy has spurred on concerns about lending interest rates. Specifically, mortgage-owners are become increasingly willing to take on longer term agreements in exchange for the ability to lock in today’s interest rates.

However, as we’ve discussed over the last week, locking in today’s interest rates might not be particularly easy for someone who has already agreed to a fixed and closed term. Because of the implications of taking on a fixed mortgage, a borrower needs to understand that their options available, while fairly limited, do still allow them a bit of flexibility to take advantage of today’s lower interest rates. The most popular of these options involves pursuing a strategy known as interest rate blending.

Interest rate blending allows a borrower to reduce the interest rate which they are paying to lender in exchange for taking on a longer loan term, and renewing their commitment to a fixed agreement. While this will not actually reduce their agreement’s interest rate to today’s market rate, it will come up with a rate that is somewhere between the previous contract’s rate and the market rate. That being said, remember that the rate will not be a perfect average between the two calculated rates.

While blend calculations are fairly proprietary, and therefore differ between institutions, it can be generalized that a mortgage blending equation will take into account both the remaining term and amortization of a loan, as well as the agreed upon interest rate and market rate. This means that the benefits of blending an interest rate will depend greatly upon the time left in both the existing agreement, and the loan itself.

Taking into consideration how it is that blending can only potentially decrease interest rates in given circumstances, we need to be sure that it’s the proper solution for us as borrowers before going through with the hassle of it. For starters, we need to make sure that market interest rates are actually below the agreement rate, otherwise we would be doing ourselves a disservice. Secondly, we want to make sure that our mortgage has been in existence for long enough to renew. Many banks won’t actually allow a rate blending until the product has been in existence for at least 4-6 months.

Lastly, we need to be sure that locking in the new rate for a longer term will not trap us financially. Many people fail to take into account the way in which rate blending obligates the borrower to take on a longer fixed term for the contract. While it may solve some shorter term cash flow problems, it doesn’t help us half way through the contract when we want to sell the home early and move.

While these seemingly obvious prerequisites might leave you feeling as though a blend is a simple procedure, but keep in mind that there’s always more going on behind the scenes than the borrower perceives. Regardless, your personal banker should always be happy to take the time to discuss what kinds of options are available for your current agreement, and how it is that apply to your specific circumstances.