Does breaking your mortgage make sense?

With mortgage rates settling at historic lows, chances are you’ve considered breaking your current mortgage and renewing or refinancing now before rates begin to rise.

Perhaps you want to free up cash for such things as renovations, travel or putting towards your children’s education? Or maybe you want to pay down debt or simply pay your mortgage off faster?

In some cases, the penalty can be quite substantial if you aren’t very far into your mortgage term, but we can determine if breaking your mortgage now will benefit you long term.

People often assume the penalty for breaking a mortgage amounts to three months of interest payments so, when they crunch the numbers, it doesn’t seem so bad. In most cases, however, the penalty is the greater of three months of interest or the interest rate differential (IRD).

The IRD is the difference between the interest rate on your mortgage contract and today’s rate, which is the rate at which the lender can re-lend the money. And with rates so low these days, the IRD tends to be greater than three months of interest. Because this is a way for banks to recuperate any losses, for some people, breaking and renegotiating at a lower rate without careful planning can mean they come out no further ahead.

Keep in mind, however, that penalties vary from lender to lender and there are different penalties for different types of mortgages. In addition, the size of your down payment and whether you opted for a ‘cash back’ mortgage can influence penalties.

While breaking a mortgage and paying penalties based on the IRD can result in a break-even proposition in the short term, it may still make strategic sense once all factors are considered. Your current goal may be to secure a long-term low rate commitment before things change, and herein lies potential significant future savings.

Jean-Guy Turcotte is a mortgage broker with Dominion Lending Centres – Regional Mortgage Group in Red Deer.

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