What is the penalty for breaking a mortgage in Canada?
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Many homeowners in Canada have recently turned to refinancing their mortgage or selling their property. All of this is due to mortgage rates reaching record levels.
Unfortunately, breaking your mortgage can lead to heavy penalties. These penalties are determined by the size and type of mortgage you have and by the time left on the term. But there are cases where breaking a mortgage can be the right move and save you thousands of dollars.
It would be worth weighing all of the costs involved before making any decision.
What does it mean to break a mortgage?
Once you obtain a mortgage to buy a home, the lender gives you a specific amount of money to repay over a specific period called the amortization. The repayment period on a mortgage is generally around 25 years, but your contract with the mortgage lender covers a shorter period, generally between two and five years, also known as the “term”.
The details of your mortgage payments stay in place for that term. When you reach the end of the term, you have to renegotiate the payment conditions with your current lender or look for a new one.
If you want the conditions of your mortgage changed before maturity, you have to break the contract, even if you stay with the same lender. Breaking the contract comes at a price, however.
Depending on the type of agreement you signed with your lender, you can, in most cases, break your mortgage contract. Read the fine print of your contract to determine whether you can break the mortgage contract if you wish to, or contact your lender to find out whether you have that option.
Reasons you might want to break your mortgage contract
There are several reasons why someone may want to break their mortgage contract. Most of the time, it will depend on your current situation.
- Paying off your mortgage early
- Your home no longer meets your needs; you want to sell your house and are considering buying a new one.
- Changes in your family situation
- Interest rates have dropped
- You want to renegotiate a new contract with better conditions.
- Mortgage refinancing to get a better rate
- You need to remove someone from the mortgage and the title.
The general rule is that switching mortgage lenders will be worthwhile if you find a mortgage rate that is 30 basis points lower than your current rate. It will also depend on how much time is left on your contract and on the penalty for breaking your loan.
The cost of breaking a mortgage
There are several costs to take into account when it comes to breaking a mortgage.
Prepayment penalty charges
The penalties will be determined by whether your mortgage contract is open or closed. If it is a closed term, the assumption is that you are prepaying the remaining balance of the mortgage and taking out a new one when you break a loan. For that reason, you will have to pay a prepayment penalty. To determine the amount of the prepayment penalty you will have to pay, you can use an online calculator.
If you currently have an open mortgage, you can break the contract without paying a prepayment penalty.
Mortgage stress test
At the end of 2017, the mortgage stress test was implemented. The stress test rules have an impact on how much you can borrow. You will have to provide proof that you can afford a mortgage with an interest rate that is 2% higher than the one your lender is granting you.
If your income has dropped or stayed the same since before 2017, and you already borrowed the maximum amount you qualified for, you will not be able to get a mortgage the same size as before once the stress test is applied. If that is your situation, you cannot break your mortgage unless you can afford to cover the additional shortfall.
Repay the incentives
Several lenders offer incentives to encourage you to take out a mortgage with them. These lenders give you a certain percentage of your mortgage as cash back. You will have to repay those bonuses to the lender if you break the mortgage.
Additional fees
Before breaking your mortgage contract, read the fine print of your agreement to see whether additional fees apply. These fees can include the following:
- Appraisal fees
- Reinvestment fees if you plan to buy a new home.
- Administration fees
- Mortgage discharge fees, which remove a charge on your current mortgage and register a new one.
The penalty for breaking a fixed-rate mortgage
The prepayment penalty is generally higher on a fixed-rate mortgage. The calculation is based on the number of months left in the term, the mortgage balance, the old and the new interest rate, as well as any rate discounts you may have received. The amount calculated is known as the interest rate differential (IRD).
The penalty for breaking a variable-rate mortgage
A variable-rate mortgage comes with a penalty equal to three times the monthly interest amount, so you will essentially have to pay three months of interest payments on your current balance to get an early release from the contract.
For some, this can be a minor expense, but for others the cost may be too high to make switching to a lower rate worthwhile.
Conclusion
As we mentioned earlier, prepayment penalties vary depending on your lender, the time left on your current mortgage contract and the mortgage contract itself.
If you are considering breaking your mortgage contract, do your research and find out about the potential fees and penalties. That way you will be prepared for any financial pitfalls you could run into. If you are still hesitating over this decision, speak with a mortgage lender knowledgeable enough to help you understand all of the regulations and rules tied to breaking a mortgage contract.
