Record low rates create a dilemma for many homeowners who are currently in a higher mortgage rate situation and are questioning the profitability of breaking their mortgage and reducing their interest rate. Is this wise after paying all the penalties associated with breaking the mortgage early?
Determine your mortgage goals
The penalty is one of the first factors to consider. First and foremost, we must determine our real needs and take advantage of the opportunity to increase our monthly cash flow or consolidate certain higher-rate debts. A personal financial check-up should be done at the same time in order to make the most of it.
There may also be a need where breaking a mortgage may make sense even if it doesn't result in savings. Improving your "cash flow" can be a valid reason to break your mortgage without necessarily talking about savings.
It is sometimes advantageous to accept a slightly higher rate if it means a significantly lower penalty knowing that you plan to break your mortgage in the next few years.
When in doubt, it is imperative that you seek professional advice to review your personal financial situation, your needs and propose the best solution.
When to break your mortgage
Depending on the product, in variable, the cost of the penalty is relatively very similar throughout the mortgage term. For a fixed product, the cost could look like hills and valleys each time you get closer to the anniversary date of the loan.
It is necessary to make calculations that may vary during the same period. Therefore, calculations and an early transaction date are highly recommended. Doing the calculations is the first step in determining when to break a mortgage for savings or other needs. This will also allow you to determine the extent of your savings, if any.
Do you have the right to break your mortgage?
Most mortgage products will allow you to break your mortgage. Let's face it, a mortgage penalty for breach of contract benefits the creditor. However, there are some products that will require you to renew or refinance with that same creditor and in the same product for a new 5 year term. It is crucial to understand your mortgage product before signing in order to anticipate these eventualities. Some products may even prevent you from selling to a family member, so ask around!
How much does it cost to break a mortgage?
Penalties can vary depending on the type of mortgage: variable rate or fixed rate. Most variable rates are three months interest and fixed rates are the greater of three months interest or the IAD (Interest Rate Differential) which can vary from one lender to another.
Although all lenders are required to post their method of calculating penalties on their website, it is imperative to confirm with your creditor, as some offsets or cash backs may be customer specific and thus added to the penalty. It is important to note that the penalties can be modified without prior notice, so it is always necessary to validate the penalty especially following rate changes.
Breaking a fixed mortgage results in higher penalties
The DTI represents the interest lost by the creditor when the contract is broken. This calculation can vary from one creditor to another. It depends on the contractual or posted rate used. It is precisely in these situations that catastrophic penalties are observed. This varies with the creditors and their calculation methods.
Some very low rate restrictive products impose a different penalty calculation based on the mortgage balance.
That said, the cost is not always about the rate. Flexibility and lower breakage costs should be a major consideration.
For those who get larger penalties, it is possible to make it all worthwhile by refinancing instead of renewing using the equity in the property to pay off the penalty.
Should you break for a fixed or variable rate mortgage? It's all a matter of calculations, strategy, profitability and needs. Your mortgage broker can guide you through the process and help you make sense of it.
Risks of breaking a mortgage
In addition to the penalty, which can be consolidated with a refinance or renewal depending on the amount involved, it is also important to compare apples to apples when using this strategy. Some borrowers take the opportunity to extend their amortization, thinking they are saving the same amount of money when in fact they are completely sabotaging the profitability of such a transaction. Yes, extending the amortization is an option when you want to increase your cash flow, but it is rarely profitable when the goal is to reduce the interest paid.
Not to mention the choice of product and creditor which can have a significant impact if a change in our situation requires a sale or refinancing during the current term.
Source : Article by Malik Yacoubi on the website lesaffaires.com on the 01 december of 2021
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