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What are the penalties if I break my mortgage?

What are the penalties if I break my mortgage?

Piggy bank with pile of coins

The Bank of Canada has announced many dips in interest rates over the past few months, so I thought it timely that we talk about the penalties of breaking a mortgage as I’ve had clients asking me recently if it makes sense for them to break their mortgage to take advantage of lower interest rates. In the midst of the COVID-19 pandemic, we have maintained the all-time low rates we saw throughout 2019, which has many thinking maybe it’s worth paying out the penalty fees for breaking their mortgage in order to capture long term savings. It definitely makes sense to run the numbers but, before you make any brash decisions there are a few things to keep in mind.

1. Your mortgage contract is likely the most complicated thing in your life

Ok, maybe there are a few other complicated things in your life aside from your mortgage contract, but all jokes aside, it’s important to have a mortgage professional review your specific contract ahead of breaking it to make sure there aren’t any clauses (basically rules) in your agreement that will have you taking a big financial hit when you make a switch to another lender.

2. Know the difference between a variable-rate mortgage and a fixed-rate mortgage.

A variable-rate mortgage tends to have an attractive rate that’s typically lower than a fixed-rate mortgage but the catch is that it’s variable. Once you’ve agreed to the variable-rate mortgage based on what the rates are the day you sign that contract, the variable-rate can go up and down like a yo-yo. More recently it’s been fairly steady, but it can change often. Whereas a fixed-rate mortgage, the interest rate stays exactly the same for the duration of your mortgage contract (usually 3 – 5 years before it renews) so you know exactly what your interest rate will be throughout the entire period, as it won’t change from what it was when you signed on the dotted line. Why it’s important to know whether you have a variable-rate mortgage or a fixed-rate mortgage is because the way the penalty is calculated is different. A variable-rate mortgage penalty is 3 months worth of interest on your current mortgage loan. A fixed-rate mortgage is a little more complicated. The penalty fees are based on something called the IRD (Interest Rate Differential). The IRD uses the difference between your mortgage rate and the current interest rate that the lender could get for a loan at the time of breaking the contract. As it’s a complicated calculation you’ll want to have your mortgage broker do the math so you know concretely what the penalty will be before breaking your agreement. There is nothing worse than running the numbers yourself, and then finding out later your calculations were a little, or a lot, off the mark.

3. Review the fine print

At the end of the day, your mortgage contract typically favours the lender more than it does yourself. They loaned you the money so they tend to make sure they will get it back with interest whether the entire contract plays out or not. This is another good reason to work with an experienced mortgage broker and not the bank because a mortgage broker will know what to look for to ensure your financial well-being is as protected as possible because we all know life changes, and sometimes those changes lead to breaking a mortgage here and there. For example, some low-rate mortgages actually put a restriction in place that you can not break the mortgage early or they ensure there is a hefty fine put in place if you do, so much so that it’s not worth it to make a change after just because the money math doesn’t make sense financially. Another thing to keep in mind is that mortgage loans that offer a cash bonus of some kind for signing with them, may have to be paid back in full, or a portion of it will need to be returned, if and when you break that mortgage.

4. What does the money side of things actually look like?

Well, let’s say you originally signed your mortgage back in July of 2017. You took a 5-year fixed-rate mortgage with an interest rate of 4.77% and you still owe $325,000 on that mortgage. That means that your IRD (interest rate differential) factor is about 0.0021. We multiply that by your outstanding balance of $325,000 and then by the remaining 38 months left in your current mortgage contract which equals about $25,523 as your actual interest rate differential. Then you have to add on a little thing called a lender discharge fee which is about $275 and covers the costs of them doing all the paperwork essentially to break the deal, which means the total penalty fee you’ll pay is roughly $25,798. That’s a pretty big fine to pay for breaking your mortgage.

Alternatively, if you had originally signed a 5-year variable-rate mortgage with an interest rate of 3.60% your penalty fee would be calculated as 3 months worth of interest. So if your mortgage payment is about $1639.83 and the amount of interest at that point in the payment is worth $591 you would multiply that $591 x 3 to give you a penalty fee of $1773. A penalty that is much easier to take care of than the $25,798 example above.

In summary, if you’re wondering if breaking your mortgage makes sense financially in this interesting time, give me, Darren Robinson a call at 705-315-0516. As your financial partner, I’ll help your navigate your mortgage contract, pointing out the pros and cons as we go through it, to help you make an informed decision as to whether breaking your mortgage today makes sense for you long term as well. In some cases, even with the high price tag of the penalty fee mentioned in our example of a fixed-rate mortgage above, the amount you pay in penalty is well worth it when compared to the possible savings over the entire lifespan of your mortgage not to mention the opportunity of having lower monthly payments now in addition to those savings. You may also be eligible to roll your current debt payments into your mortgage to help consolidate your debt further reducing financial strain even more. Let’s take a look at your options, and make a plan for growth in your financial future together.

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