Being offered a better mortgage rate can seem very enticing at first glance. After all, who doesn’t love the idea of lower monthly payments – especially in an ongoing pandemic? However, that being said, breaking your current mortgage doesn’t come without its own set of repercussions.
Whenever you break a mortgage, you are required to pay a pre-payment penalty. This penalty protects your lender, who was anticipating interest from your mortgage for a given period of time. Getting out of your contract with them comes at a price.
For those with variable rate mortgages, you will be required to pay a three-month interest penalty. Meanwhile, those with fixed rate mortgages have to calculate three months of interest and the interest rate differential (the difference between your old mortgage and new mortgage interest rate). You will then be asked to pay the larger figure of the two sums.
Patricia Lovett-Reid, CTV’s Chief Financial Commentator, breaks it down in laymen’s terms in a recent article for CTV:
“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.”
As you can tell, that sum isn’t exactly pocket change. While the new rate you have found may seem attractive at first glance, it’s important to make these calculations first and determine if you’ll be saving money by switching or breaking close to even by making the change. That final figure will be key in deciding whether breaking your current mortgage is worth it for you.
The best way to make sure you are working with the right numbers is to ask your financial institution to break them all down for you. From there, you will be able to gain the clarity you need to figure out what suits you best in the long run.