Are Big Savings in Your Future? First, Answer a Couple Questions…
As previously reported, Canadian interest rates are at a 20-year low. You may be seeing ads with mortgage rates as low as 1.69% and news reports confirming those low rates are here to stay – at least for the next year. If you are in the middle of a 5 year, 3.54% fixed-rate mortgage you might think you are missing out on serious savings right now.
It’s true. Breaking your mortgage and switching to a lower rate could save you hundreds of dollars every month, or shave years off the length of your mortgage but that’s not the whole story. Here’s the other truth – breaking your mortgage doesn’t always equal saving money. Depending on your loan, there is a penalty fee that you will certainly face that could cost more than you are saving. But then again, saving isn’t always the number one goal.
Our team is receiving daily inquiries from clients who want to break their existing mortgage to take advantage of today’s lower rates. Here’s some information for those of you who are wondering about switching products and want to understand the cost implications of that decision. We have a few questions to ask you, so read below and we’ll walk you through it.
Question 1: Why are You Asking?
Here are the top 3 reasons for breaking a mortgage:
- Reduce the total cost (or years) of mortgage
- Consolidate other debt into mortgage
- Reduce monthly payments
These reasons stem from a variety of life events that impact the decision-making process around breaking a mortgage. You may be unable to keep your original commitment because you are moving or have recently lost a job. You may be looking to take more control over your various debts so that you can plan to save money more effectively. Or you may simply want to benefit from substantial savings to be had… The first question that you should ask yourself is: “Are you looking to cut cash flow needs in the short term, or save on total spend in the long run?”
Question 2: How Much Will it Cost You?
Most mortgages can be broken but you have to be careful about penalty conditions that were agreed to in your original mortgage contract. Breaking this contract before the end of your agreed term could result in a very large fee that is required to be paid in cash. Your lender is effectively penalizing their client for breaking the terms of the contract. They were counting on the interest payments that all parties agreed to and the advantageous change for you is likely disadvantageous for the lender. Alternative to a large lump-sum payment, the penalty could also be a fee that could be rolled into your next loan product. This is why the second question you should answer is: “How much is breaking the mortgage going to cost me?”
The Calculation: Variable vs. Fixed Rates
The type of mortgage that you currently have holds the biggest impact on your penalty fee calculation. Standard variable/adjustable rate mortgages have a very simple penalty calculation – 3 months’ simple interest regardless of the contract terms. Fixed rate mortgages – which are most popular with Canadians – have a much more complex calculation for their penalty fee structure. In most cases, the lender considers the cost of three months’ interest and compares that to the total “Interest Rate Differential” (IRD) – where they pick the highest of the two numbers. The IRD calculation factors in posted rates (sometimes at the time you signed your mortgage) and all the months that remain in your term – both of which can significantly raise the cost of the penalty. If you want to take the next step and try to run your own numbers through a calculation, here’s a great article that can help you do that: click here to read more.
Questions Answered? Next Steps…
The only way to find out what your penalty would be is to contact your lender directly. So that’s the absolute first step that you need to take if you are considering breaking your mortgage contract. Our team can help you answer that question and all the others that follow – such as, what are the new terms available to you? What do you qualify for today? Our team is seasoned on this subject matter and we’re happy to take you through the process so that you can decide if the fees associated with breaking your mortgage is worth the solution that exists for you on the other side.
