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