Breaking Your Mortgage: A Comprehensive Guide
Many Canadians find themselves breaking their mortgages before the end of the term, driven by a variety of circumstances. In this blog post, we’ll explore key considerations for those contemplating this decision.
Breaking for Various Reasons
Canadians break mortgages for reasons such as refinancing, moving, switching lenders, or life events requiring a property sale.
Closed vs. Open Mortgages
Breaking a closed mortgage before its term incurs penalties, whereas an open mortgage allows for prepayment without penalties.
Variable vs. Fixed Rate Mortgages
Generally, breaking a variable rate mortgage is less expensive, often with a 3-month penalty. Fixed-rate mortgages may involve a penalty calculated as the greater of a 3-month penalty or the Interest Rate Differential (IRD).
Understanding IRD Penalties
The IRD penalty is the difference between your current mortgage interest rate and what the lender can charge for a similar term. For longer-term mortgages, such as 5 years, IRD penalties can be significant.
Additional Costs
Breaking a mortgage may entail other costs, including admin, discharge, and legal fees. It’s important to be aware of these potential expenses.
Covering Costs When Breaking
Ideally, if breaking your mortgage for a cheaper one, the cost should cover all expenses, including penalties and additional costs.
Lender-Specific Calculation Methods
Different lenders have varying methods to calculate IRD penalties. This can involve posted rates, discounted rates, prime rate, prime rate plus a fee, and some are tied to the 3 or 5-year bond rates, or they may have a percentage fee. It’s important to review your mortgage contract for specific terms and how it’s calculated.
Impact of Posted Rates on Penalties
Banks usually have a higher posted rate, and the contract rate is discounted from the posted rate. If you break the mortgage, the penalty will be based on the posted rate, significantly increasing your penalty. Monoline lenders are often slightly better with more favorable terms.
Flexibility with Variable Mortgages
Variable rate mortgages provide flexibility, allowing you to break the mortgage by typically paying only 3 months of interest.
Considering a Second Mortgage
If you have a favorable rate and wish to avoid breaking your mortgage, consider a second mortgage. However, this depends on the terms of your first mortgage.
Strategic Planning
If you anticipate the need to break your mortgage during the term, consider a variable rate mortgage or a lower fixed term for better flexibility.
Navigating the complexities of breaking a mortgage requires careful consideration of these key points. Understanding the nuances empowers you to make informed financial decisions.
Thinking about breaking your mortgage? Reach out for a consultation to assess if it makes sense for your unique situation.