Why Homeowners Might Want to Do The “Unthinkable” And Break their Mortgage
Is “breaking your mortgage” a phrase that triggers alarm bells in your brain? If you’re proud of your on-time payments and wary of expensive penalties, that’s not a surprise.
Your mortgage makes it possible to live in your home, and you agreed to follow every term and condition when you signed the paperwork. You probably never dreamed of paying penalty fees or bowing out before the end of your 15 or 30 years.
The good news is that breaking a mortgage isn’t the end of the world. In fact, breaking a mortgage can sometimes be the best thing you do.
Yes, breaking a mortgage does mean breaking a legal commitment, but it’s not illegal and it’s not always ill-advised. In fact, sometimes it’s inevitable. You’re not taking a step backwards this way, especially if you’re breaking a mortgage for debt consolidation purposes.
Breaking a mortgage is a financially savvy move for some homeowners (and the only possible move for others), and it might be right for you too. Simply put, breaking a mortgage is a common occurrence that many people choose to do to get more favourable rates and benefits.
Whether you’re buying a new house or exploring new financial options, don’t discount the possible benefits of breaking your mortgage.
Not sure where to begin? Here are some of the answers you’ll need as you weigh your options and consider breaking your mortgage.
Can You Break Your Mortgage?
This answer is simple: yep! Any mortgage can be broken unless otherwise mentioned in the contract.
That’s why your loan terms already include prepayment penalties, administration fees, and other costs associated with ending the contract early. That said, just like getting a second mortgage, breaking a mortgage isn’t the right option for everyone, and some lenders make it easier than others.
If you want to break your mortgage, the process will depend on your original lender’s conditions. This usually means paying a penalty, but it may also include fees, cash repayments, and other costs. Of course, if you arrange your next mortgage with the same lender, you may get a break on paperwork and penalties.
Why Should You Break Your Mortgage?
So, when is breaking a mortgage a good idea? Most homeowners who make this decision have one of a few common reasons. If any of them apply to you, you might want to consider this path too.
Note: Remember, it’s important to consult with your mortgage broker before undertaking any significant steps, such as breaking a mortgage.
Here are the most common reasons to break your mortgage:
Get Better Rates
Sometimes, breaking and refinancing your mortgage saves you so much in interest that it’s worth the extra costs. Do you qualify for interest rates that are much lower than your current rate?
Sometimes, at the mid-term point in your mortgage, it can be better to switch from one lender to another. For example, if you have a variable rate mortgage of Prime Minus 0.5%, but you’re able to get Prime Minus 1%, we can move your mortgage from one lender to another.
You’d also have to add on a 3-month interest penalty doing this, but you’d save money by the end of your term. This is a great option, especially if it comes up in the first few years of your mortgage contract. These changes aren’t considered refinancing, either, because you’re not re-registering for a lien; you’re simply taking it from the existing lender, erasing their name, and putting a new lender’s name on it.
Mortgage interest charges certainly add up over the years, but the rates themselves are still lower than almost any other type of loan. Why not roll other debts into your mortgage? If you have high-interest credit cards, car loans, or personal loans, breaking your mortgage could create the opportunity to renegotiate a loan that includes all of these debts under one new, low interest rate.
Buy a New Home
Want to sell a house you haven’t paid off? Don’t worry; you’re not the only Canadian who decided not to stay in the same place for up to 30 years. Listing a property that’s still in mortgage is common, and your lender will give you a payoff quote before you start the process.
Breaking a mortgage can let you access equity in your home—we’ve already touched on this.
That money can offer you a way to invest in a business or get one of your own off the ground. If you’re self-employed, that money can help you fund significant purchases that would otherwise be hard to get a loan for.
Taking equity out of your home gives you easy access to money you’ve built up over time.
Avoiding Mortgage Penalties
Lenders usually charge prepayment penalties when borrowers back out of contracts early, because they’re losing out on all the interest they would collect from future payments. Mortgages are no exception, and mortgage break fees could include months’ worth of projected interest costs and other fees.
Of course, sometimes the financial benefits outweigh these expenses, but you need accurate numbers to know if that’s true. So, how do you estimate your mortgage break penalty?
Your lender will tell you exactly what it would cost to repay your mortgage early, and the number is impossible to predict precisely because they have to compare different interest rates and trends. However, you can get a rough idea by looking at your current mortgage terms and using online calculators. Any mortgage penalty calculator will take most of these factors into consideration:
- Current interest rate
- Original interest rate
- Current balance
- Original mortgage amount
- Months or years remaining (when is the maturity or renewal date?)
Each lender has different policies, but these figures will have the biggest impact on the fees you have to pay. One common fee is a three-month prepayment penalty, which is equal to three months’ worth of interest. Another common mortgage break fee is a certain percentage of your principal balance.
Understanding Mortgage Rate Penalties
Fixed rate penalties are typically calculated via the Interest Rate Differential, which is the difference between your original rate and the current interest rate charged if the lender was loaning funds out for the rest of the term.
You might also see three months’ worth of interest as a penalty on fixed rate mortgages, but, usually, it boils down to whichever option is greater.
By comparison, variable rate mortgage penalties are typically the three-month prepayment penalty.
It’s also worth noting that every lender operates slightly differently, and the penalties between a bank, credit union, and mortgage company may vary.
Typically, if a borrower breaks a fixed rate contract at a bank, the penalty is four times bigger than breaking a fixed rate contract with a mortgage company. This is because banks calculate penalties based on posted rates at the time you go the contract to the discount rate available for the term remaining on your mortgage.
This means, in a lot of cases, borrowers are paying penalties that equate to 3% or 4% of the balance of their mortgage.
For example, a good friend of mine was selling his home. He had a $280,000 mortgage with a bank. The penalty to break the contract was $11,800, but if the mortgage had been with a mortgage company, the penalty would have been $2,400.
It’s not fun paying those penalties, but one’s definitely more painful than the other.
Finding the Right Fit
While I always recommend discussing these things in detail, as a general rule of thumb, most borrowers with a down payment below 20% should chose a mortgage with a mortgage company.
When the down payment is more than 20% of the purchase price, it takes a bit more due diligence in studying the pros and cons of which mortgage lender type is most suitable for your situation. Of course, this all depends on the current rates. If you’re struggling to find the right solution, I’m always here to help!
Understanding Your Payment Schedule
Your remaining mortgage balance – the amount you still owe – is an important number, but lenders care just as much about your schedule for repaying it. That schedule is what determines the amount of interest they would have collected, had you stuck with the loan.
If you want to break your mortgage, you should understand your current payment schedule and then consider every detail of your next loan’s terms.
For example, how many payments do you make each year? How big are these payments? How many payments are left on your payment schedule, and how much of each payment goes toward the principal?
Finding the Best Mortgage Rates
Ready to start a new mortgage with a better interest rate? Like a first-time home buyer who is carefully choosing their first mortgage, your job is to collect quotes and compare terms until you find the right home loan for you.
Fortunately, unlike a newbie buyer, you now have mortgage experience and a longer credit history to help you out. You may also have more advantages than you had before, such as shorter terms, smaller mortgages, and economic upswings, all of which bring down mortgage interest rates.
Need more broken mortgage tips? Breaking your mortgage is an unconventional but effective way to lock down a lower interest rate and reduce your monthly expenses. However, it’s not the right move for every borrower. Consult a mortgage broker to compare mortgage rates and learn more about this financial option, including your potential mortgage break fees and how to get the process started.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Dominion Lending Centres, independently owned and operated. Smart Debt broker #12236.