According to mortgage industry experts, more than half of Canadians end their mortgages before maturity. The reasons they may choose to break their mortgage vary: finding better interest rates, needing home renovations, changing family composition, moving for work, or kids going off to university. If you choose to break your mortgage outside of your renewal period, you will pay a penalty. So, when does it make sense to end your mortgage early and how does the process work?
How are mortgage penalties assessed?
Mortgage penalties are intended to compensate lenders for the money they’ll lose if you break a mortgage contract. The majority of mortgages can be broken, including fixed and variable rate mortgages. Penalties are usually less if you’re breaking a variable mortgage. The penalties for breaking a fixed-rate mortgage can be high enough that it won’t be a good financial choice to break a fixed-rate mortgage simply to refinance.
Variable rate mortgage penalties are straightforward. They amount to the total of three months’ interest on your loan.
Fixed rate mortgage penalties are calculated using a figure called the interest rate differential (IRD). This rate can vary depending on your mortgage contract, but it will be the higher of two rates: three months of current mortgage interest on your loan, or the IRD. The lender can use the posted interest rate or a discounted interest rate to determine the IRD which can cause significantly higher penalties for some fixed-rate mortgages. In practical terms, someone with a $250,000 fixed-rate mortgage who breaks it after 3 years could pay a penalty of $7,600 with a bank that uses the posted interest rate to determine the IRD, while the same mortgage amount with an alternative lender using the actual interest rate could charge as little as $1,800 in mortgage penalties.
What are alternatives to breaking your mortgage?
If you move, you can take your mortgage with you. This is also called “porting” your mortgage. You can only port your mortgage if you’re buying a new home and selling your old one at the same time.
If you foresee breaking your mortgage during its term, you can also prepay a larger portion than you might otherwise have done. Many mortgages allow you to prepay a set percentage of the principle in one lump sump. If you prepay a portion of your mortgage, you will reduce the portion of your outstanding balance that used to calculate your mortgage penalty.
You may also negotiate lower penalties if you’re refinancing your mortgage with the same lender. There’s no guarantee, but mortgage rates and terms are negotiable.
Are there additional costs related to breaking a mortgage?
Unfortunately, yes. When you break a mortgage you will take out a new mortgage, also referred to as refinancing. Refinancing a mortgage entails additional fees. You still must complete an application, credit check, and usually, an additional title search and home inspections. If you’re still in your home, some of this may not make sense, but the lending process means you will need to cover some additional costs when you break your mortgage and refinance — even with the same lender.
If you’re considering breaking your mortgage, whether for a better interest rate or for family or personal reasons, use InsuranceHotline.com’s mortgage penalty calculator. You will quickly see an estimate of penalties to help you make a more informed financial choice.