Should I break my mortgage early?
The house you’ve had your eye on for years comes up for sale and you jump at it, interest rates have dropped or another lender is offering you what appears to be a better deal, you’ve recently gone through a separation or divorce, or your spouse passed away and you can’t carry your house on your own, you got a promotion but it means relocating to another area, or you’ve finally had enough of the too-small kitchen and sharing a bathroom and want to move up to a larger house. Life and needs are constantly changing and unfortunately, these changes don’t always coincide with your mortgage term. Sometimes, it’s necessary to break your mortgage contract so you can re-jig your finances, make a move or just get on with things. So what’s involved?
The cost to break your mortgage contract (also referred to as a prepayment penalty or break fee) depends on a few things:
Is your mortgage “open” or “closed”? An open mortgage, as the name suggests, offers more flexibility, including the ability to break the mortgage with no penalty. A closed mortgage, on the other hand, is a little more restrictive and there is a penalty for breaking out of the mortgage early. Open mortgages come with a higher interest rate than closed variable- or fixed-rate mortgages so it’s no surprise, then, that closed mortgages are by far the more popular choice for Canadians.
What are the prepayment penalties for closed mortgages? Well, that now depends on the type of mortgage you have – fixed or variable.
The prepayment penalty on a variable-rate mortgage is usually three months of interest.
For a fixed-rate mortgage, the break fee is the greater of either a) three months of interest or b) the interest rate differential (IRD). With the IRD, your mortgage lender is seeking to recoup what they will lose by releasing you from your mortgage and lending the money at current rates.
The prepayment penalty on a closed fixed-rate mortgage can be financially disastrous so proceed with caution! Find out exactly what your penalty will be along with any other costs levied by the lender. If you received any cash back when you first obtained your mortgage, you’ll likely have to repay it. Not all lenders calculate IRD the same way and the differences can sometimes amount to thousands of dollars. It helps to know which lenders have the most reasonable prepayment penalties and this is one of the most important factors to consider when choosing a lender – another advantage to dealing with an independent mortgage professional who can choose from many different lenders and get you a mortgage that combines a great rate with fair and reasonable terms.
So…back to the original question – should you break out of your mortgage?
It’s not a decision to be made lightly, that’s true, but sometimes it does make sense to pay the penalty for a longer-term positive outcome. For example, in a debt consolidation situation, when you calculate the cost of carrying high-interest debt vs the cost of breaking your mortgage and rolling your debt into a new mortgage, lowering your overall monthly payment and simplifying your life with one payment as opposed to several, you might find that it’s actually more cost-effective to pay the penalty. Obviously, no one wants to pay a penalty (and potentially a pretty hefty one) if there is no clear need or advantage in doing so, but if you are contemplating making a decision that will necessitate breaking your mortgage, the absolute best thing to do first is to get advice from an Invis broker who can review your mortgage contract, compare the costs and benefits of breaking the mortgage, and discuss other options with you.