To break or not to break - your mortgage that is.

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It’s one of the most common questions I’ve received since the start of the year. With rates at an all-time low, it’s got people reevaluating not only their mortgage, but their entire financial picture.

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Before you decide on whether breaking your mortgage is the right course of action, you first need to understand what it means. When you go through the mortgage process, whether you’re buying or refinancing a property, you have the option between a fixed or variable rate.

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A fixed rate is simply an interest rate that is most commonly locked in for a 5 year period. It allows you to have a predictable mortgage payment up until your 5-year term is complete, after which you can either renew with your current bank, or shop around yet again for the best rates.

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A variable rate is an interest rate that fluctuates with the market. It’s designed for individuals with an appetite for risk, whereby your payment will adjust based on the interest rate in the market at any given time.

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Now, that lock-in period allows the bank to have a level of certainty around how much money they’ll make on what they lend out to you. If you decide to “break” your mortgage early, you’re essentially throwing a wrench into the banks revenue forecast, and for that, you need to pay a penalty (we’ll get to that in a second).

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Before you decide to break your mortgage, ask yourself the following questions:

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1. What’s your objective?

People decide to break their mortgage for a number of reasons. The most common ones include moving, consolidating debts, renovating your home, taking a vacation or purchasing an investment property. Building and using equity in your home is a huge advantage, as long as you’re using it for the right reasons. Make sure you’re clear on your objective and the impact breaking your mortgage will have. It’s always a good idea to seek professional advice to ensure you’ve thought through everything.

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2. What’s your penalty?

Often times, the largest expense you’ll incur is the penalty you have to pay to break your mortgage. It’s a factor you should consider when deciding between a fixed or variable rate. Fixed rates most commonly have a higher penalty, calculated using a bank formula called an “Interest Rate Differential”. It’s essentially a way for the bank to understand what it’s going to cost them to “re-loan” out the money you’re paying back and at what rate (i.e. one Toronto couple had to pay $35K to break their fixed mortgage).  A variable rate on the other hand simply requires 3-months worth of interest payments to break your mortgage. Relatively speaking, you’ll face a much lower penalty if you’re currently locked into a variable rate.

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3. Additional Fees

When you decide to break your mortgage and refinance, you’ll incur additional costs such as lawyer fees to set up the mortgage with the new bank. As well, some lenders will require a new appraisal on your property which could be a cost passed on to you. Always ensure you ask the right questions upfront to understand the full picture of what breaking your mortgage entails - this is exactly where a mortgage broker comes in handy!

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There is no right or wrong answer. Understanding your objective is the most important piece in this entire equation. If my primary objective is to lower my monthly payments to free up additional cash every month, then I don’t really care about the additional fees or penalty. However, if my goal is to pay down my mortgage as fast as possible, all of a sudden the penalty and additional fees matter much more.

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If you’re wondering whether breaking your mortgage is the right move, don’t hesitate to reach out and I’d be happy to run through it with you. The advantage of a mortgage broker is that these services come at no obligation or cost to you, and it always helps to have the right advice to make an informed decision.

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