Should You Be Breaking Your Mortgage?
Are you thinking about breaking a mortgage early? Most people assume that when they sign up for a 5 year fixed rate that they have to stay in that mortgage for the next 5 years…that isn’t true in most cases. While there are a few lenders out there who have “closed” mortgages that are not breakable without a bona fide sale of the property, the vast majority are breakable.
So how does that work? If you decided that the rate you were paying was too high or you wanted to add funds in a refinance or various other situations that made you want to break the mortgage you were in, how can it be done? If your current mortgage rate is less than lender’s rate on the equivalent remaining term, you simply pay a 3 month interest penalty…for example:
- Current mortgage of $150,000 @ 3.25% with 3 years remaining
- Lender’s 3 year rate is currently 3.45%
- 3 Months interest = $1,219 approximately ($150,000 x 3.25% /12 x3)
What if the opposite is true, the current rate you have on your mortgage is higher than the current available from the lender? Now we enter the world of IRD, or Interest Rate Differential, this is where things get a little crazy. Technically, what is supposed to happen is you compare your rate and remaining term against the lender’s current rate for that term and work out the difference the lender will lose by you breaking their contract, like this:
- Current mortgage of $150,000 @ 3.25% with 3 years remaining
- Lender’s 3 year rate is currently 2.75%
- IRD Penalty is $2,250 (Rate difference = .50% x 3(yrs)= .015% x 150,000)
This seems simple enough, except what rate does the lender use for their rate? You see, in the past, we all received the posted rate, so it was a simple calculation. Now, since we brokers have pushed the lenders for bigger discounts, some lenders now use the discounted rate, but which one? For most of the lenders we deal with that are non-banks, they only have one rate posted, so it makes it a little easier to figure out their rate for the calculations.
Some lenders will take the discount you received on the 5 year rate in the first place, i.e. 1.50% off of posted, then apply that to the 3 year posted rate. This can cause a massive IRD penalty and is unrealistic, as they would never discount their 3 year that much (lender’s tend to discount their rates more the longer you lock in). Each lender seems to have their own way of calculating it. The Federal Government has actually made rumblings about making the rules in this area more straight forward over the past few years, but nothing has come of it.
There is more to this penalty calculation thing as well…speaking to your Bank about the penalty can lead to more confusion. It seems branches have a few different ways to calculate the penalty and many of my clients have had experiences of a quote with higher penalties unless they asked for it in writing. If you do ask for it in writing, make sure to obtain the date the penalty quote is good until (some lenders give it to you only for the day, others, 2 weeks or a month).
In many cases, it may make sense to break your mortgage, pay the penalty and then move to a lower rate that will save you back the penalty and many times more. However, you will be entering the murky world of Bank/Lender retention where they will try to do what it takes to keep you as a client. Be wary of blend and extends, unwritten penalty quotes, penalty waives etc. The goal should always be to maximize your mortgage and find the shortest route to your Mortgage Freedom Day! If you can, get some objective advice when reviewing your options if you are thinking about breaking your mortgage, all the better.
Guest Post Bio: Michael Anthony Lloyd is a Mortgage Expert with DLC Canadian Mortgage Experts and has helped Canadians with their mortgages as a Mortgage Broker since 1999. Helping Canadians reach their “Mortgage Freedom Day” sooner is his goal. He writes a Blog called The Daily Dig as well as leading the DLC CME team of 75 brokers.
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