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Sunday, August 28th, 2016

Breaking your mortgage: ‘It’s either worth it or it’s not’

Fixed-rate mortgages are at historic lows but if you are locked in to a contract with your bank, those benefits may be yet elusive.

First you have to do the math to see if breaking your contract is worth the penalties you may face.

“There is no grey area,” says Cindy David, a certified financial planner at Dupuis Langen Financial Management Ltd. in Vancouver. “It’s either worth it or it’s not.”

The big five banks are offering four and five year mortgages at just 2.99%.

“We’re even seeing 10-year fixed rate mortgages at 3.99%,” says Ms. David. “Think about that:  Interest and principal at 3.99% for 10 years. From a financial planning perspective if any client approached me and said ‘Should I look into breaking my mortgage?’ My answer would be yes.”

Step one comes down to meeting with your financial institution and doing the math to determine whether or not the cost of breaking your mortgage is worth the anticipated savings from the lower rates. The fact is the penalty for breaking a mortgage can be thousands of dollars and in many cases, the cost and the future savings cancel each other out, in which case you may be wise to wait until your mortgage is up for renewal.

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When you cancel or break a mortgage you will be charged the greater of three months’ interest or the Interest Rate Differential better known as IRD in mortgage land. “IRD is an arbitrary number based on a formula the lender has predetermined to ensure the lender breaks even,” says. Ms. David. “Not all lenders use the exact same formula so you have to go to your financial institution directly to understand what the Interest Rate Differential is and what your penalty will be.”

Invis mortgage brokerage in Vancouver provides an actual calculation they conducted for a client. The client was mid term in a fixed-rate mortgage with a current balance of $286,691 at 4.49% due to mature on March 1, 2014. In this case, the IRD applied and the penalty came to $11,505 plus the legal and appraisal fees to obtain a replacement mortgage of about $1,200. The interest to be saved by getting a new mortgage at 3% was just $8,982. In this case, it did not make sense to break the mortgage.

One way to decrease the penalty is to make the most of your prepayment privileges before ordering your payout statement, says Laura Parsons, mortgage expert, BMO Bank of Montreal in Calgary. “For example, our maximum prepayment is 20% of the original mortgage — not the current balance. On a $60,000 mortgage that means you can prepay $12,000. Prepaying first and then calculating the penalty on the revised balance will lower the penalty.”

Another option: rather than doing an early renewal and paying the penalty, it may make sense renew early and blend and extend your mortgage. “That means the bank will take the going rate and your existing interest rate and blend them,” says Ms. Parsons.

“It’s a pro-rated happy medium rate.” Minus the penalty.

If it does make sense to break your mortgage in order to take advantage of the new low rates, both Ms. David and Ms. Parsons advise to maintain the repayment schedule you’ve already put in place. This will save you tens of thousands of dollars in interest costs over the life of the mortgage.

“These are in depth conversations you should have with a mortgage specialist,” says Ms. Parsons. “If the penalty is $20,000 what is the ROI on the lower rate? How long are you going to have the house? If you’re planning on moving in three years, don’t take a five-year mortgage or at least understand what’s going to happen at that time if you plan to break the mortgage. Make your decision based on a lot of factors. And if you’re looking for peace of mind, as many people are, ask your bank for historic trends on rates. Unfortunately, there is no crystal ball, but it may help give you a sense of what to expect.”

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