The past two years of the covid-19 pandemic has definitely shaken our plans and shifted our goals due to the hazier future ahead of us. Who would have predicted that city-dwellers would have a mass exodus from their urban lifestyle and choose to move and live in a more decongested, peaceful town in the outer reaches of Ontario’s capital? With the increase in the demand for homes, home prices skyrocketed. Combined with the cutting of mortgage rates to help stimulate home buyers, it is a great time to sell houses or refinance your mortgages. Maybe you’ve come across the option of breaking your mortgage— this means making changes or ending your mortgage contract before maturity or the end of your term. Why do people do it anyway?
Reasons why you may want to break your mortgage contract
According to the Financial Consumer Agency of Canada, the reasons why you may want to break your mortgage contract are the following:
- interest rates have gone down – you may want to refinance your mortgage to lock in a better rate, either with your current lender or a new one.
- your financial situation has changed – maybe you will want to pay off your mortgage early or renegotiate with better terms.
- you want to buy a new home and are planning on moving
- your family situation has changed – maybe you want to remove someone from the mortgage or title of the property or renegotiate with better terms.
- your home no longer meets your needs – maybe you want to sell your home.
No matter what your reasons are for breaking your mortgage, it is possible for you to be charged with a penalty. Read your mortgage contract first and be aware of the costs associated with breaking your mortgage before doing so.
Costs associated with breaking your mortgage contract
Below are some of the costs you may incur when breaking a mortgage:
- Prepayment penalties – This is the largest cost you’ll be charged. If you have a fully open mortgage, you won’t need to pay this. However, if you have a closed mortgage, you will need to pay a prepayment penalty. The cost will differ based on your lender, mortgage contract, and time left in your current mortgage contract term.
- Administration fee – This is for the process of switching to a new contract where you need to fill-out a new application and go through a credit check. It can cost around $1,000 or more.
- Appraisal fee – This can range between $250 and $550.
- Re-investment fees – Only if you are trying to purchase a new home
- Mortgage discharge fee – If you want to remove a charge on your current mortgage and register a new one
- Cash back – This is an optional feature where your lender gives you a percentage of your mortgage amount in cash.
Prepayment penalty fee calculation
The prepayment penalty depends on what type of mortgage you have and how much you still need to pay before maturity. It also depends on whether you have a variable or fixed mortgage rate.
- Variable Rate Mortgage
It is easier to calculate a prepayment penalty when you have a variable rate mortgage. It is also often lower. Canada’s National Housing Act mandates that for variable-rate mortgages, the penalty is always equivalent to three months’ interest.
Current Interest Rate x Mortgage Balance x 3 Months = Prepayment Penalty Payable
Example:
You have a current balance of $200,000 remaining on your mortgage and you have 3 years (36 months) remaining on your contract. Your annual interest rate is fixed at 3.5%. The mortgage interest rate posted by the lender at the time of signing was at 4.8%. The current posted interest rate for a 3-year mortgage is 4.1%.
Computation:
Interest amount in a year = $200,000 x 3.5% = $7,000
Interest amount per month = $7,000 / 12 months = 583.33
3 months’ interest = 583.33 x 3 = $1,750 Prepayment Penalty Payable based on 3 months’ interest
- Fixed Rate Mortgage
If you have a fixed rate mortgage, your fee will be the higher amount of the two following prepayment computation:
- Interest Rate Differential (IRD) – The IRD reimburses your lender for the interest they will lose because you are breaking your mortgage contract early. Below is the calculation:
(Mortgage Interest Rate – Current Market Rate) x Mortgage Balance ÷ 12 x No. of months left on Mortgage Term = Prepayment Penalty Payable
Using the same scenario example in the variable rate mortgage section, the computation based on IRD is as follows:
(4.8% – 4.1%) x $200,000 / 12 x 36 months =
0.7% x $200,000/ 12 x 36 months =
1400 / 12 x 36 months =
116.67 x 36 months = $4,200 Prepayment Penalty Payable based on IRD
- 3 Months Interest – This penalty fee is the equivalent of three months’ interest on your current mortgage
Now that we’ve outlined the potential costs you might encounter from breaking your mortgage, you can better estimate if it is worth it or not. If you are set on breaking your mortgage, here are some ways for you to avoid paying a large penalty.
Tips to avoid paying a large penalty
- Know your mortgage contract – Take note of the terms and fees stated. You might have a prepayment privilege where you can pay more of your mortgage each year with a lump sum payment and/or increase your monthly payment amounts without having to pay a penalty every year. Any upcoming prepayment penalties will be based on a lower mortgage balance. The Financial Consumer Agency of Canada advises that you “make a lump-sum prepayment before you break your mortgage. Some lenders restrict your ability to prepay if you’re close to the date you break your contract.”
- Port your mortgage – This is an option if you want to break your mortgage because you want to sell your current home and buy a new one. Porting your mortgage means carrying your current mortgage (existing interest rate, terms, conditions) to your new home. Ask your lender if this is a workable option for you.
- Have your house buyer assume your mortgage – This is an option if you want to break your mortgage because you want to sell your current home. While this might seem like a good idea for the seller/ mortgage borrower, not all lenders allow this as this is a long and tiresome process. The house buyer/ new borrower will also need to be able to qualify for the mortgage based on the lender’s standards.
- Blend and extend your mortgage – This option means blending your existing fixed-rate mortgage (higher rate) with the current (lower) rate if you extend your term.
Breaking your mortgage comes with several costs. It is important that you know these fees so you can decide if it is the best financial decision to make. Speak to your lender to know the options open for you before you break your mortgage contract. You can also consult with a mortgage broker who can advise you on a more appropriate solution based on your mortgage situation. Mortgage Broker Store is a team of licensed mortgage agents and brokers that can help you understand your mortgage contract better, the fees and implications of breaking your mortgage, and give you the best options they can offer. We work with a network of private lenders across the GTA to help you get a variety of financial options at the best possible rate. You can contact us at 647-493-4855 for free advice.
