Thinking about breaking your mortgage early? Before you sign your lender’s paperwork, let’s look at what the costs of doing so could be. Knowing your options before you break your current mortgage and take on a new one is the difference between forking over tens of thousands of dollars (or more) in penalties and saving your hard-earned moolah for other goals on your bucket list.
Why People Break Their Mortgage
First we have to start by saying that breaking your mortgage isn’t a bad thing. Roughly 6 out of 10 homeowners break their mortgage in the first 3 years of their term.
You might be moving, going through a relationship change, or you want to leverage equity from your property for other investments.
There are many reasons to break your mortgage, but two of the main reasons we see people break a mortgage is to save money; either with a lower rate when it becomes available or by consolidating high-interest debt.
And when the Financial Consumer Agency of Canada reports that two-thirds of Canadians holding a mortgage are struggling to keep up with their financial commitments. Saving where you can, when you can, is more than just a smart idea; it’s a necessity.
How Penalties Are Calculated
Breaking a mortgage early usually comes at a cost. The cost you’re stuck with depends on whether you have an open or closed mortgage, variable or fixed interest rate, and other calculations that vary with each lender.
There are two main penalties at play: the 3-month interest rate penalty and the interest rate differential penalty (IRD).
This is where we get a little mathy, but it’s worth seeing the differences in penalty.
Let’s run through an example:
You have $500,000 left in your mortgage
There are 3 years left of your 5-year term
Your interest rate is either 3% if it’s variable or 3.99% if it’s fixed
Variable Rate Mortgage
For a closed, variable interest rate mortgage, the 3-month interest rate penalty would be approximately $3,750.
For illustrative purposes only. Actual numbers depend on your current mortgage and lender.
Notice how the time remaining isn’t a factor because it uses 3 months in its calculation. However, some lenders use your contract rate while others use the prime rate.
Fixed Rate Mortgage
For a closed, fixed-interest rate mortgage, your lender will charge you the greater of the 3-month penalty ($3,750) or the IRD.
Calculating the IRD is a little trickier and not all lenders calculate it the same way.
We first have to find the interest differential. From your 3.99% fixed rate, your lender will subtract their own current rate for a 3-year term, to match the 3 years left in your contract. Theoretically let’s say 2.99%. That’s a differential of 1%.
From there, they divide the interest differential by 12 months to get a monthly differential and then factor the remaining mortgage ($500,000) and remaining term (36 months) to come up with a penalty of approximately $15,000.
Still with us so far? A $3,750 3-month penalty is an easier pill to swallow than a $15,000 IRD penalty.
But, that’s up to your contract and lender (time to dust off that mortgage contract for some light reading).
Some contracts will allow the lender to use their posted rate instead of your fixed rate, which is typically higher and can potentially land you with an even larger penalty bill.
But wait, there’s more. On top of either the 3-month penalty or IRD, you may also be on the hook for:
A prepayment penalty
Administration fees
Reinvestment fees
Appraisal fees
Mortgage discharge fee, and/or
Legal fees
Enough About Penalties. Let’s Talk Pros And Cons of Breaking Your Mortgage
Pros | Cons |
You can save thousands of dollars in interest over time with a lower rate, allowing you to put those savings in the right places.
Your monthly payments can be lower if your new contract has a longer amortization period.
You can take advantage of market fluctuations in a constantly evolving financial market, giving you a chance to adjust your financial strategy and manage your debt better.
You may find extra cash on hand for other investments like stocks, bonds, or real estate with lower monthly payments.
You may be able to get better mortgage features than your existing mortgage has, such as better options in payment frequency, prepayment privileges, or just better service. | You may end up paying more in penalties and fees.
You can end up paying more interest over the lifetime of your mortgage if you extend your amortization period.
You might lose certain mortgage advantages – prepayment privileges, portability, and insurance benefits – to name a few.
You’ll have to pass the mortgage stress test again and prove your ability to make your monthly payments when interest rates rise.
This process may impact your credit score as we have to re-qualify you to refinance. |
There may be other factors you may want to add to your own pros and cons list. So, if you’re curious to see if breaking the mortgage makes sense in your situation, connect with one of our knowledgeable team members to get the full scoop.
The Process Of Breaking A Mortgage
Here’s a simple rundown of what breaking a mortgage may look like:
Review your mortgage agreement. Look at the terms and conditions of your mortgage related to prepayment penalties, breakage fees, and any conditions for early termination.
Calculate the costs in penalties and fees based on your mortgage type, remaining term, and interest rate. If you don’t want to do the math, that’s where you give us a call.
Compare the alternatives such as blending and extending your mortgage, negotiating better terms with your lender, or “porting” (more on that later).
Consult with a mortgage professional. This is where we come in! Get the personalized advice based on your financial goals to paint a clearer picture of the potential costs and benefits. We live for these moments.
Notify your lender. Once you decide to go through with breaking your mortgage, your lender will guide you with your next steps.
Pay the penalties and fees. This is the hard part, but on the plus side, these costs may be deducted from the proceeds if you're refinancing or selling your property.
Complete the paperwork and make it official.
Check your credit report to make sure the mortgage discharge is accurately reflected, especially if you plan on applying for new credit in the future.
Luckily, You Have Options
Finding a mortgage that works for you is all in the details. Near the top of those details should be the lender you choose to work with. Most of us walk into the bank we’ve dealt with since we were young and say, “I’ve been such a loyal customer for so long. I need a mortgage and I’m sure you will give me a great deal. Where do I sign?” Just hold on for a second.
These banks usually have differential penalties that can do some real damage to your wallet. Alternative mortgage lenders can have much lower, more fair mortgage breakage penalties.
By now, you may be having second thoughts about this mortgage-breaking mumbo jumbo. Thankfully, there are other options to optimize your mortgage.
You may be eligible to transfer or switch your mortgage from one lender to another. Find a lender who will pay off your existing mortgage so you can start anew with better terms, a lower interest, or improved customer service.
The previously mentioned process of porting your mortgage brings your existing mortgage from your old home to your new one, generally without any prepayment penalty.
Or, go the refinancing route and take advantage of a lower interest rate and better terms with the help of your home’s equity.
Of course, these options will come with a different set of penalties and fees and eligibility requirements. But you may still come out on top if the numbers work in your favour.
Bottom line: do the research or seek a mortgage professional before you make anything official and reach out to one of our mortgage experts when you’re ready to do a mortgage review.
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