When should you break your mortgage for a better rate?
TORONTO -- If you’ve found yourself enticed by a better mortgage rate or another lender offering something more competitive, there’s something you should ask yourself.
Does it make sense to break my current mortgage and lock it in at a lower rate?
Some families are also looking to free up cash due to layoffs associated with COVID-19 and may need to refinance their mortgage, while others might just decide to sell their home.
Regardless of the reason you might have to break your current mortgage, you will likely have to pay a penalty.
A pre-payment penalty protects your lender who was counting on interest payments from you for a specified period. When you pay your mortgage off quickly, no matter how you do it, your lender is getting less than they anticipated in interest payments and you have to pay a price for changing or opting out of the contract.
If you have a variable rate mortgage, you will have to pay a three-month interest penalty. However, if you have a fixed rate mortgage you will have to calculate three months of interest and the interest rate differential (the rate you have compared to the rate you will get) and pay the greater of the two options.
Let's break it down in a back of the envelop calculation: Assume you have a $200,000 variable rate mortgage at 3 per cent. You would have to pay a three-month interest penalty of $1,500.
If, however, you had a fixed rate mortgage at 4.29 per cent with 23 months remaining in your term and wanted a new rate of 2.39 per cent, you would have to calculate the interest rate differential or three months of interest and pay whichever is higher.
A rough calculation suggests the three-month differential of $7,283 is the amount, excluding fees, you would have to pay as it is greater than the three months of interest amount of $2,145.
The actual calculations are a little more complex, but this gives you an idea of what to look for.
To get a more accurate picture you could ask your financial institution to run and compare the numbers or go on a site like Ratehub.ca and enter in the variables that apply to you.
Before you break your mortgage, here’s what to remember:
- Know there will be a penalty.
- Have your financial institution break down the numbers for you.
- Understand there will be fees and that every bank is a little different.
- The penalty you pay has to be less than the gain you will achieve or it simply isn't worth it.
Knowing your numbers makes this an easy decision.