Did you know that according to CMHC, six out of 10 Canadian homeowners break their mortgage on or before the third year of a five-year mortgage? That means that 60% of homeowners break their mortgage before it’s due and while very few expected to have to the ones who planned ahead saved themselves thousands of dollars. They often need to break a mortgage for a variety of reasons but the most common ways that I see are:
- Sale and purchase of a new home
- To take equity out/refinance
- Health challenges or life circumstances change
- Company/job transfer
Regardless of the reason, breaking a mortgage means you’re breaking a contract and there will be a fee involved. How that looks varies widely between lenders, but there are two types of penalties:
Set penalty – this is typically a fee equal to three months of the interest payments and is typically found in a variable rate mortgage or offered by some lenders available only through a mortgage broker.
Interest Rate Differential – this fee is calculated by factoring the difference between your mortgage interest rate, the interest rate that the lender can charge today and the length of time remaining in your term.
That generally sounds complicated enough, but to throw a major wrench into the calculation it’s important to know that lenders calculate things differently. Some will compare your current rate to what they are currently offering and some lenders will calculated it compared to a much higher posted rate.
Let’s see how these two calculations can mean a difference of over $10,000!
Lender A offers a mortgage with an Interest Rate Differential penalty. The interest rate is 2.89% with a penalty calculated on current rates at the time you need to break the mortgage.
If after 3 years you break your mortgage at at that time the interest rate they’re offering is 3.35%. That gives you an IRD of .46% x 2 years remaining. That’s .92% multiplied by the remaining mortgage balance. A $300,000 mortgage would have a penalty of $1,380.
Lender B offers a mortgage with an Interest Rate Differential penalty but calculated on their posted rates. In this case it may be offering new clients an interest rate of 3.35%, but their posted rate is 4.89% based on the Bank of Canada posted rate.
In this same scenario of breaking a $300,000 mortgage after three years would have an IRD of 2% x 2 years remaining. The total penalty would be $12,000.
While no one really plans to break their mortgage before the 5-year term, no one really plans a divorce, health issues or needing to sell their home and move.
It’s important to work with an independent mortgage broker who can not only help you find a great interest rate, but will also protect you from high hidden fees when life happens. A good mortgage broker ensures you’re paying the least amount of interest and that doesn’t always mean the lowest interest rate a bank is showing you. Email Steve White or call 905.903.4799 to find out how he can help you with your home purchase or refinance.