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What’s the Penalty of Breaking a Mortgage in Canada?

Several homeowners in Canada have recently turned to either refinancing their mortgages or selling their properties. This is all because of mortgage rates that have reached record-breaking lows.

Unfortunately, breaking your mortgage can come with hefty penalties. These penalties get determined by the size and type of mortgage you have and the remaining term. But, there are instances where breaking a mortgage can make sense and save you thousands of dollars.

It would help if you considered all the costs involved before making any decisions.

What Does it Mean to Break a Mortgage?

Once you get a mortgage to buy a house, the lender gives you a specific amount of money to pay back over a specific period called amortization. The period you repay a mortgage is usually around 25 years, but your contract with the mortgage lender is for a shorter period, usually between two to five years, also known as the term.

The specifics regarding your mortgage payments stay in place for that term. When you reach the end of the term, you need to renegotiate the payment terms with your current lender or search for a new one.

Should you wish to have the terms of your mortgage changed before the end of your term, you have to break the contract, even if you remain with the same lender. Breaking the contract will come at a price, though.

Depending on what kind of agreement you have with your lender, you can, in most instances, break your mortgage contract. Read your contract’s fine print to determine if you can break the mortgage contract should you wish to do so, or contact your lender to find out if you have that option.

Reasons Why You Would Want to Break Your Mortgage Contract

There are various reasons why someone would want to break their mortgage contract. Most of the time, it will depend on your current circumstances.

  • Paying off your mortgage early
  • Your home no longer meets your requirements; you want to sell your house and are planning on buying a new home
  • Changes that have been made to your family situation
  • Interest rates have dropped
  • You want to renegotiate a new contract with better terms
  • Mortgage refinance to get a better rate
  • You need to remove someone from the mortgage and the title of the property

The general rule of thumb is that switching mortgage lenders will be worth it if you find a mortgage rate 30 base points lower than your current rate. It will also be dependant on the remaining term of your contract and the penalty for breaking your mortgage.

The Costs of Breaking a Mortgage

There are various costs when it comes to breaking a mortgage to consider.

Prepayment Penalty Fees

Penalties will get determined based on whether you have an open or closed mortgage contract. If it’s a closed contract, it’s an assumption that you are prepaying the remaining outstanding mortgage early and then getting a new one when you break a mortgage. Because of this, you will get charged with a prepayment penalty. To determine how much you will pay for a prepayment penalty, 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 got implemented. The rules to the stress test affect the amount of money you can borrow. You will have to provide proof that you can pay a mortgage with an interest rate that’s 2% higher than what your lender will give you.

If your income has dropped or stayed the same before 2017, and you already borrowed the maximum of the amount you qualified for, you won’t be eligible for a mortgage size that’s equal to the one before once the stress test is applied. If this applies to you, you can’t break your mortgage unless you can afford to pay the additional shortfall.

Pay Back Any Incentives

Several lenders offer incentives to lure you into taking a mortgage with them. These lenders provide a certain percentage of your mortgage as a cashback to you. You will have to pay the incentives back to the lender if you break the mortgage.

Additional Fees

Before you break your mortgage contract, read the fine print of your agreement to see any additional fees are applicable. These fees can include the following:

  • Appraisal fees
  • Reinvestment fees if you plan on buying a new home
  • Administration fees
  • A mortgage discharge fee – removes a charge on your current mortgage and registers a new one

The Penalty of Breaking a Fixed Rate Mortgage

The prepayment penalty is generally higher on a fixed-rate mortgage. The calculation gets based on the term’s remaining number of months, the outstanding balance on the mortgage, your old and new interest rates, and any rate discounts you may have received. The calculated amount is known as the interest rate differential (IRD).

The Penalty of Breaking a Variable Rate Mortgage

A variable rate mortgage has a penalty three times the monthly interest, so you will essentially pay three months of your current balance’s interest payments to get released early from the contract.

This can be a minimal expense, but the cost might be too high to take advantage of securing a lower rate for others.

Conclusion

As mentioned before, prepayment penalties vary based on your lender, how much time remains on your current mortgage contract term, and the mortgage agreement.

If you’re considering breaking your mortgage contract, do your research and educate yourself on potential fees and penalties. This will prepare you for any financial pitfalls you may face. If you are still wary of making this decision, speak to a mortgage lender who is knowledgeable enough to help you understand all the regulations and rules that come with breaking a mortgage contract.

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