Last updated: January 18, 2022
What this tool is all about:
This tool estimates what penalty you would pay on your mortgage(s),which usually occurs if you are trying to sell a property or want to switch financing options prior to the mortgage maturing.
It’s important to confirm this penalty with your lender, since the calculation methodologies can differ slightly and the figures calculated below should only serve as an estimate. All details outlined below can be found in your mortgage commitment letter.
A mortgage penalty is a fee set by the lender that you must pay if you decide to break your mortgage. You might be thinking, why would someone want to pay more money just to get out of their mortgage? Essentially, the penalty fee will compensate the lender for the interest they would be losing out on if you decide to break your mortgage. Breaking your mortgage could potentially save you thousands of dollars, however it’s not guaranteed even with a significantly lower interest rate. This will all depend on the type and size of mortgage you have as well as the remaining time left on the term. To learn more about prepayment terms and penalties, read here.
When you get a mortgage to buy a home, a mortgage lender will give you a loan that you must pay back in a specific amount of time, which is called the amortization period (e.g. 30 years). The term is the length of time you are committed to the mortgage rate and lender conditions, which is typically a shorter amount of time (e.g. 1 – 5 years). Once the term is over, you are required to renegotiate the terms of payment or look for a new one. However, if you choose to change the terms of your mortgage before the end of the term, this is considered breaking the mortgage. In short, breaking a mortgage means that you are moving away from the payment schedule you had initially agreed to before the term is up, which will result in a penalty fee.
There are two options to consider, open and closed mortgages. The major deciding factor between the two will depend on your ability to pay off the mortgage during the set term. The type of mortgage you have will play a large part in determining the penalty for breaking your mortgage.
With this type of mortgage, you have the ability to completely pay off or refinance before the end of term without having to pay a penalty fee. This mortgage would be beneficial in the case of a salary increase or other financial windfall, as you would be able to pay off a substantial amount and save on interest fees. However, open mortgages often have a very short term of 1 year or less and they usually have higher interest rates, compared to a closed mortgage.
With this type of mortgage, you will not be able to fully pay off or refinance before the end of term without having to pay a penalty fee. You are tied to the repayment terms and conditions you agreed on for the duration of the term. This mortgage is beneficial for someone who wants a fixed monthly mortgage payment. A closed mortgage can sometimes offer some payment flexibility, such as allowing increased monthly payments by a certain percentage or allowing an additional lump sum payment per year without penalty.
|Open mortgage||Closed Mortgage|
|Completely pay off or refinance before the end of term without having to pay a penalty fee||Not allowed to fully pay off or refinance before the end of term without having to pay a penalty fee|
|Beneficial if you plan on changing mortgages in the near future (within 6 months)||“Beneficial for someone who plans on keeping the same mortgage for a longer period of time”|
|Often have a short term of 6-12 months and they usually have higher interest rates||Typically have terms of 1-10 years with competitive interest rates|
It may have been some time since you signed your mortgage and the details might be a bit blurry to you. Don’t worry, this can happen to a lot of people especially if you have pre-authorized withdrawals set up. An easy way to check whether you have an open or closed mortgage is to check your mortgage statement, as it will always have the details laid out there. You can also speak to your mortgage advisor to help you find the details.
|Variable rate mortgages||Fixed-rate mortgages|
|The penalty fee is always 3 months interest||The penalty will be the greater of the IRD or 3 months interest|
|Lenders have different reference rates, which are usually the actual interest rate or their Prime Rate||IRD calculations vary by lender|
There are several different factors to consider before breaking a mortgage. The most important thing to consider is the cost of refinancing before opting to break your mortgage. Sometimes switching mortgages can result in a long payback period for a prepayment penalty, so it’s important to calculate how much you would really be saving if you do break your mortgage including penalties, not just the new interest rate. You also need to compare options with your current lender with other lenders so you know what the best choice is. It is always best to consult with your mortgage advisor before making a decision.
|Lower interest rate||Paying more in the long run due to fees and mortgage penalties|
|Pay off your mortgage faster||Undergo the stress test again in order to re-qualify for a new mortgage application. Depending on the economic conditions at the time, you might not qualify for a mortgage anymore|
|Change your mortgage terms to suit your financial situation better|
|Lock in a lower interest rate for the new term of the mortgage|
|Access the equity in your home if you need funds|
It’s a good idea to shop around and compare different mortgage rates to ensure you get the best deal. Perch mortgage advisors (and in general, mortgage brokers) are trained to represent borrowers when obtaining financing to buy their homes. Since they are not employed by any one financial institution, they are not limited to the products they can offer you and are the best bet when it comes to finding the best mortgage that fits your needs. If you are looking to break your mortgage, using our mortgage penalty calculator and consulting with a mortgage advisor is a safe way to know whether you are making the right decision.
Sign up today for a Perch profile to connect with a mortgage advisor today.