The basics of breaking your mortgage
When you sign your mortgage contract, you’re agreeing to a strict payment schedule for a set term. Those terms may have looked fine at first, but you know that life is unpredictable. If circumstances change, you could face mortgage penalties and extra fees. Here’s what you need to know about breaking your mortgage.
What is breaking a mortgage?
Paying off your mortgage early, changing its terms or getting out of the contract completely is called breaking your mortgage. Note that it is not the same thing as stopping your mortgage payments altogether. Breaking your mortgage often comes with a hefty price tag, and these mortgage penalties can be as scary as they sound.
These are some of the reasons you might need to consider breaking your mortgage:
- Your family situation has changed. Janine and Kevin bought a new home together, but they didn’t last as long as their mortgage will. Suddenly, both need to downsize.
- Your financial situation has changed. Kevin just won the lottery and would like to pay off his mortgage early – like in about half an hour.
- Interest rates drop. Interest rates drop, which might mean that a new mortgage for Kevin could lower overall costs, even factoring in penalties.
So will breaking your mortgage break the bank? It depends.
The consequences of breaking your mortgage
If you have an open mortgage, then there’s no cost to breaking it. An open mortgage lets you pay off the entire mortgage at any time and change terms at any time. That said, almost no one has an open mortgage – you likely don’t, either. For closed mortgages, which you likely have, the formula to determine your fee is based on whether you have a fixed-rate or variable-rate mortgage.
If you have a fixed-rate mortgage, you will have to pay either three months of interest as a penalty or the interest rate differential (IRD), whichever is higher. The IRD is almost always higher, so here is how to calculate it:
Banks tend to use the posted rate for this calculation, while other lenders use the original contract rate. But check the details with your lender to be sure.
For variable rate mortgages, the formula is much simpler. You usually have to pay three months interest as a penalty if you break your mortgage. To calculate this, do the following:
Either way (fixed- or variable-rate), you will have to pay. Additional costs such as administration, appraisal and discharge fees may also apply. If your lender offered you cash back, you might need to repay some of that, too.
How to get the best chances of avoiding mortgage penalties.
With the proper planning and research, it may be possible to minimize or possibly dodge some of these fees entirely.
- Pay the maximum pre-payment amount possible. Lenders don’t want you to pre-pay your mortgage all at once, but most will allow you to pay extra up to a specific annual limit. Pay as much as you can as soon as you can.
- Port your mortgage. You can take your existing contract with all the terms and port it to another property. Because your mortgage remains intact, you are not technically breaking your agreement, and you can avoid a penalty fee.
- Blend and extend. A blend-and-extend mortgage is when you take your current mortgage rate and combine it with a new one. You're technically keeping your existing mortgage, but extending the term and getting an interest rate that's somewhere between your old mortgage rate and current rates.
- Have the buyer assume your mortgage. Selling early? Your lender may allow the buyer to inherit your mortgage, and your buyer might be open to it. But don’t take this as a given. The buyer may have their own obstacles to face and your lender may not agree.
Your ultimate choice on whether to break your current mortgage comes down to if, after adding up all the fees and penalties, it’s still a better deal to do so than remain on your current mortgage. Unfortunately, there is no one-size-fits-all answer for that, so go over the numbers carefully, preferably with an expert mortgage broker or your lender.
Breaking your mortgage is intimidating and possibly quite expensive. But if you must do so, it’s best to speak with a financial expert first. With some careful planning, you can reduce – or possibly eliminate – many of the associated fees.
Information obtained from REW.ca and Zak Khan.