Should I break my mortgage terms? The pros and cons

Signing a mortgage agreement feels like one of the biggest commitments you can make in life. But just like many other choices, there is always an opportunity to make a change. Whether you find a better interest rate or your financial situation changes, there are several reasons as to why people opt to break their mortgage terms.

But while you may be faced with having to pay a prepayment fee or penalty, there are actually pros and cons to this financial decision. 

The pros of breaking your mortgage term

Getting a lower interest rate

Maybe you bought your home during a time when interest rates were at an all-time high–and now, they’re much lower than you imagined. This is one of the most common reasons for people to explore the option of breaking their mortgage terms. A small percentage decrease in your rate can actually very heavily affect the amount of your mortgage payments over time and how much you can actually save on interest. 

Hypothetically, let’s say your current mortgage rate is 5% and after two years you notice the economy shifting and the Bank of Canada’s rate declining. You decide to explore some mortgage options and you notice places now have a consistent rate of 3.5%. When it comes to paying interest on a mortgage, a 1.5% difference has a pretty big shift in the amount of interest you pay over time: this decrease could reduce your monthly payments by over 20%. Overall this means less money being in interest and more opportunity to pay off your principal balance.

Which means, you could end up paying off your mortgage faster 

If you break your mortgage terms, you could end up with a lower interest rate as well as smaller monthly payments than before. Ultimately this adds up to the possibility of paying off your mortgage faster. If you’re still able to make the same monthly payments as you were before you broke your terms, you can put that extra money towards lump-sum payments, and possibly pay off your mortgage faster than you expected.

Your monthly costs could become less

One of the reasons you may break your mortgage terms is to lower your monthly payments. And if you end up finding a better rate, it’s no surprise that your monthly costs may shrink as well. To do so, it might be time to look at a longer amortization period. 

Freedom to take advantage of market fluctuations

The financial market is ever-evolving, and locking yourself into a long-term mortgage might prevent you from capitalizing on favourable shifts. By breaking your mortgage terms, you have the flexibility to adjust your financial strategy according to the current market trends. This agility could result in substantial savings and allows you to be more proactive in managing your largest debt.

Improving your cash flow for other investments

With lower monthly mortgage payments, you might find yourself with extra cash on hand each month. This additional liquidity can be redirected towards other investment opportunities, such as stocks, bonds, or real estate, further diversifying your portfolio. An improved cash flow can also act as a safety net for unforeseen financial challenges.

Potential for better mortgage features

Beyond just interest rates, other mortgage features might have evolved since you first signed your agreement. Perhaps there are new options for payment frequency, prepayment privileges, or even hybrid rate options. By breaking your current mortgage terms, you might gain access to these beneficial features, giving you more control over your financial journey.

Strengthening your financial well-being in the long run

Taking the step to break your mortgage terms isn't just about the immediate benefits. It's about a strategic decision that could set you on a path of stronger financial health for the years to come. The combined effects of lower interest rates, reduced monthly costs, and enhanced mortgage features can contribute to a more secure and comfortable financial future.

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The cons of breaking your mortgage term

Paying high penalty fees 

In Canada, breaking a fixed or variable-rate mortgage both come with a penalty, regardless if they are open or closed mortgages.

With a variable-rate mortgage, if you break it you’ll often have to pay a penalty of three months’ worth of interest. With a fixed-rate mortgage, the penalty for breaking your mortgage will be determined by what’s called an interest-rate differential (IRD). Your lender will calculate this by determining the difference between the amount of remaining interest on your current rate and your new rate, in the remaining months of the mortgage, which are rounded up to the nearest year.  

That’s why it’s important to do the calculations, because the penalty fees alone could cost you more than what you’re saving in interest, if you break your term.

You’ll have to pass the mortgage stress test, again

Qualifying for a mortgage starts with Canada’s mortgage stress test. In simplified terms, this test is to see if your current financial situation proves you can pay your mortgage on a monthly basis. However, if you’ve changed jobs recently, or experienced a shift in your finances, there’s a possibility you may not qualify again. 

You may end up paying more in fees over time

In addition to the penalty for breaking your mortgage, there are several other fees that come with this decision. These could include: 

• A prepayment penalty
• Administration fees
• Reinvestment fees
• Appraisal fees
• Mortgage discharge fee 

The total cost of these fees can vary based on your mortgage terms as well as your lender, so it’s important to connect with your advisor to help you see the bigger picture. 

Potential impact on your credit score

When you break a mortgage, it may require you to undergo another hard credit inquiry. Such inquiries can have a temporary negative impact on your credit score. Although the dip may be minor, if you’re planning on taking out other loans or credit lines in the near future, this is something to keep in mind.

Loss of certain mortgage benefits

Your current mortgage might come with certain perks or benefits that are unique to that agreement or lender. This could range from cash back rewards to discounts on related banking services. By breaking your mortgage, you may risk losing out on these added values, which might not be available with your new mortgage.

Time and effort involved

Breaking your mortgage is not just a financial decision; it also requires a considerable amount of time and effort. From doing the necessary research and meeting with mortgage brokers to potentially undergoing the approval process all over again, it's a commitment that can be both mentally and physically taxing.

Potential for rate hikes in the future

While breaking your mortgage could give you a better rate now, it's essential to consider the possibility of rates rising in the future. If you're moving to a variable-rate mortgage because of its current attractiveness, remember that these rates can increase, which might offset the initial savings you achieve today.

Risk of a lengthened amortization period

While securing a lower interest rate can lead to reduced monthly payments, it’s crucial to consider the potential implications on the length of your mortgage. Without careful planning, you might find yourself inadvertently extending the amortization period, which can lead to paying more in interest over the lifetime of the mortgage.

Are there alternative options?

So what happens if you need to apply for another mortgage but don’t want to break your terms? There are actually still two options around that you might consider:

Blend and extend

Before your term ends, you might be allowed to extend the length of your mortgage. Choosing this blend and extend option will allow you to mix your old interest rate with the new term’s interest rate. Not only does this give you a happy middle ground on your rate, but it also helps you avoid penalty fees, although admin fees might still apply. 

Port your mortgage

This is an option for you if you’re looking to purchase a different property or are thinking of upsizing or downsizing. It allows you to take your existing mortgage term, rate and conditions and port it directly over to another property. 

Add a co-borrower

In situations where you might be struggling with the financial commitment of your mortgage, adding a co-borrower can be a solution. This could be a partner, a family member, or a trusted friend. By adding a co-borrower, you could potentially benefit from their financial stability and creditworthiness, making it easier to manage the mortgage. It's essential to discuss this option with your lender, as there might be associated fees or conditions.

Refinancing for a home equity line of credit (HELOC)

If you've built significant equity in your home, you might consider refinancing for a HELOC. This gives you access to funds using your home as collateral. While this doesn’t necessarily replace your mortgage, it provides flexibility in managing your finances. You can tap into the equity when needed and pay it off at your pace. However, remember that the interest rates on a HELOC can be variable, so it's crucial to factor in potential rate fluctuations.

Renegotiate with your lender

Sometimes, simply opening a dialogue with your existing lender can lead to new possibilities. If you have a solid payment history and have been a loyal customer, your lender might be willing to negotiate certain aspects of your mortgage to keep your business. This could mean better terms, reduced fees, or even a rate adjustment in some cases.

Utilize mortgage payment privileges

Many mortgage agreements come with built-in features that allow for occasional increased payments or lump-sum payments towards the principal without incurring penalties. By taking advantage of these privileges, you can decrease the total interest paid over the term of the loan and potentially shorten the life of the mortgage.

So what should you do?

Deciding to break your mortgage terms isn’t an easy decision. While a lower interest rate may seem initially appealing, it’s important to understand the longer-term costs of breaking your terms and decide if the savings (and hassle) are worth it. 

If you have questions about your mortgage terms or our current rate options, one of Pine’s mortgage advisors would be happy to help. Just fill in our quick-and-easy mortgage application and one of them will be in touch.