What You Should Know About Breaking Your Mortgage Early
The Coronavirus pandemic has caused much uncertainty and instability in the lives of many Canadians, but there is one aspect of the economy that has remained relatively unphased: the Real Estate Market. Although home sales and home prices across Canada experienced a slump during the initial stages of the nationwide lockdown, July data saw numbers bounce back and flourish. Home sales officially grew past pre-pandemic levels and home prices increased more than 14% since July of last year.
With home sales and home prices on the rise throughout the country and mortgage rates at record breaking lows, many Canadians are thinking about refinancing their mortgages or selling off their existing properties. As tempting as it may be to lock into a lower interest rate or cash out on your house that's tripled in value, it might not be the best timing for some homeowners. Unless your mortgage term is coming up for renewal within the next 6 months to 1 year, or if you’re about to reach your amortization period, breaking your mortgage can cost you a hefty sum. However, if you are refinancing your mortgage to pay down higher interest debts in the form of a home equity loan for debt consolidation purposes, the prepayment penalty might prove to be well worth it. Alternately you might be better off getting a short term second mortgage to hold you over until your 1st mortgage is due for renewal. At that time you can refinance both the second mortgage and the first mortgage into one low interest rate, provided that rates continue to stay low.
Before you start thinking about breaking your mortgage, it is important to understand the potential costs you might encounter.
Reasons To Break Your Mortgage Contract
There are several reasons why a homeowner might want to break away from their mortgage contract, including:
- Selling your home
- Paying off the mortgage early
- Mortgage refinance to lock in a better rate
- Renegotiate a new agreement with better terms
- Removing someone from the title of the property and from the mortgage
Whatever your reason may be for getting out of your mortgage early, it is possible that you may be charged a prepayment penalty. A good mortgage broker can help you become familiar with your mortgage contract and understand more about the process and any potential costs that you would encounter.
If your main goal for breaking your mortgage is to put yourself into a better financial situation, you should always factor in the costs before making any final decisions. Depending on your mortgage agreement and your lender's requirements, you could stand to benefit a great deal by breaking your current mortgage early and refinancing the entire amount, or you might end up realizing that the process will end up costing you more than you would make in the long run.
Cost Of Breaking Your Mortgage
Breaking your mortgage early could result in some costs that you have to cover as a homeowner, including but not limited to:
- Prepayment penalties
- Administration fee
- Appraisal fee
- Re-investment fees (if you are trying to purchase a new home)
As we mentioned above, prepayment penalties will vary based on your lender, mortgage agreement and time left in your current mortgage contract term.
Breaking A Variable Rate Mortgage
If you have locked yourself into a variable rate mortgage, you will likely be looking at paying a maximum of three months of interest payments on your current balance to be released from the contract early. For the most part, this expense is minimal and both the short-term and long-term financial benefits can greatly outweigh this cost. For some borrowers however, this expense might be a little too high to truly benefit from locking into a lower rate. This is when it would be beneficial for you to speak with a knowledgeable mortgage broker or your current lender and decide whether or not your penalty is something you can comfortably afford.
If you are interested in doing the calculations yourself, you can multiply your mortgage rate with the current sum of your mortgage. Once that is done, you can multiply that number by three. That sum will be the amount that you will owe with your prepayment penalties. This will give you a rough estimate of what your prepayment penalties may be, though you should really speak with your mortgage broker or lender to get a precise and accurate figure.
Prepayment Penalty Calculation for Many Variable Rate Mortgages:
Prepayment Penalty Amount = Current Interest Rate x Mortgage Balance x 3 Months
For example, if you have a mortgage balance of $400,000 and your current monthly mortgage payment is $2,500 a month of which $500 goes towards paying interest and the remainder towards paying down the principal, then here is how you can calculate a rough estimate for your mortgage prepayment penalty on many variable rate mortgages using the figures in this example:
Prepayment Penalty Amount = $500 x 3
Prepayment Penalty Amount = $1,500
Breaking A Fixed Rate Mortgage
If you are locked into a fixed rate mortgage, your prepayment penalties might get a little bit more complicated to calculate on your own. Most lenders require fixed rate borrowers to pay back the larger of the two: three months interest or interest rate differential.
An interest rate differential is determined by using your current interest rate and subtracting that by the current market rate. You must then multiply that number with your remaining mortgage balance and then multiply that amount by the number of months left over on your mortgage.
Prepayment Penalty = (Mortgage Interest Rate – Current Market Rate) x Mortgage Balance ÷ 12 x # of Months Left On Mortgage Term
For example, let's say you have a current balance of $400,000 remaining on your mortgage and your current mortgage rate is 3.80% annually with monthly mortgage payment of $2,500 a month. If you have 15 months left on your mortgage term and the current interest rate that your bank can now offer that same $400,000 mortgage to someone else is 1.80% annually, then the bank will want to earn that 2.00% difference by charging you a prepayment penalty equal to that 1.00% for the remainder of your term.
Here is how you can calculate a rough estimate for your mortgage prepayment penalty on many fixed rate mortgages using this example. Remember this will give you a rough idea of your prepayment penalty, but you should always talk to your lender or mortgage broker to get the final accurate amount before deciding to break your mortgage:
Prepayment Penalty Amount = (3.80% - 1.80%) x $400,000 ÷ 12 x 15
Prepayment Penalty Amount = 2.00% x $400,000 ÷ 12 x 15
Prepayment Penalty Amount = $8,000 ÷ 12 x 15
Prepayment Penalty Amount = $10,000
Depending on the numbers used in your calculations and mainly by the months left on your mortgage, the amount you would owe might be in the thousands of dollars. If you are looking to resign with your current lender, they may be willing to reduce your penalties in order to make you stay. However, it is always beneficial to shop around with other lenders since customers that are refinancing with the same lender are typically given less competitive rates than new customers. Your best option is to always speak with an experienced mortgage broker who can provide you with unbiased information and sound advice on the most suitable mortgage solutions for your financial future.
Avoiding A Hefty Prepayment Penalty
If you are contemplating breaking your mortgage but feel yourself getting swayed by the thought of having to potentially pay thousands in penalties, these are some things you can look into.
- Know Your Contract Inside And Out: Read your mortgage contact closely and make sure you are familiar with all of the options and terms included. This can potentially give you a legup if you end up wanting to break your mortgage contract early. Certain contracts will give you the options to pay down more of your mortgage each year with a yearly lump sum payment and/or increasing your monthly payment amounts without having to pay a penalty. You can take advantage of this annual lump sum or increased monthly payment clause in your contract to your advantage when you break your mortgage early in order to have to face a lower prepayment penalty.
- Blend And Extend Mortgage: If you are interested in extending your mortgage but want to avoid paying a prepayment penalty, you can opt for this option. It allows you to mix your current interest rate with the current market rate being offered and create a new rate somewhere in between. You would need to speak with your lender or a mortgage broker to learn more about this option and whether it would be a financially beneficial solution for you.
- Port Your Mortgage: If you are breaking your mortgage in order to sell your home and buy a new one, you can speak with your lender about the potential option of porting your mortgage to the new property. This option allows you to transport your current mortgage to your new property and might be able to help save you unnecessary prepayment costs. Porting your mortgage can save you money and time in the long run, but not every lender is willing to allow it. Talk to your lender or mortgage broker about whether porting your mortgage would be a viable option for you.
- Allow Your Home Buyers To Assume Your Mortgage: If you are breaking your mortgage in order to sell your home, your buyers could potentially take over your mortgage so you don’t technically have to break the contract. Although it seems like an ideal option for borrowers who are looking to sell with no strings attached, not all lenders are open to the idea and could make it a tedious process to undergo. If your mortgage lender is open to this, the new borrowers (the buyers) will need to be able to qualify based on the lender's guidelines.
All in all, when breaking your mortgage contract the most important thing you can do is educate yourself on the potential fees and penalties that come with your mortgage so that you are prepared and ready to make the best financial decision possible. Besides your own research, it is always recommended to speak with a knowledgeable mortgage broker who can help you better understand the rules and regulations around breaking your specific mortgage contract.
The hardworking team of mortgage brokers at Clover Mortgage are experienced with helping our customers breaking mortgage contracts while ensuring the borrower always comes out on top. We will work alongside you and your lender to make sure you are making the right choice for your financial future.
Call or text us at 416-674-6222 or email us directly at info@clovermortgage.ca to speak with one of our experienced mortgage brokers today.
