The term breaking your mortgage often has a negative meaning to it, but that’s not necessarily the case. The main reason why someone might decide to break their mortgage is to get a lower rate with their bank or another lending institution. When the Investor’s Group cut its three-year variable mortgage rate to 1.99% last month, many of my clients wondered if breaking their mortgages and switching would be a wise decision. The question is, do the long-term savings outweigh the initial interest penalties? It is possible, however let’s have a closer look at the various considerations.
The number one factor to consider before breaking your current mortgage is the interest penalty you will incur. The interest penalty depends on the type of mortgage you have (fixed or variable) and which bank or lender you’re with.
You can find mortgage penalty calculators online such as at Ratehub.ca - simply enter in your remaining mortgage balance, the type of mortgage, your mortgage rate and term and the calculator will provide you with an approximate calculation for your mortgage penalty amount. As an example if you are breaking a $200,000 mortgage with TD and have a fixed mortgage rate of 2.99 percent, you would have an interest penalty of approximately $9,800.
With a fixed rate mortgage, the interest penalty is calculated using what’s called “interest rate differential calculation.” The penalties are also different if you have a variable rate mortgage or a cash-back mortgage – check with your financial institution for details and be sure to read and understand the fine print. Some lower rate mortgages may have a provision that the mortgage cannot be broken unless you sell your home.
Once you've determined your penalty, it’s just a matter of working out if the interest savings will be greater than the penalty paid. In general, if the offered rate is greater than two per cent less than your current mortgage rate, it might be worth paying the penalty and switching.