Know Your Options When
Breaking a Mortgage:
As a whole most people are not nearly as proactive as they should be in the monitoring and management of their mortgage debt. By not effectively negotiating or re-evaluating your current mortgage when the market changes you could be wasting thousands of after tax dollars that can never be regained.
Here is what you need to know if you are breaking, or looking at breaking an existing mortgage. If you are paying off a closed mortgage before the contract end most lending institutions are going to charge you the greater penalty amount of three months’ or interest rate differential.
Three Months Interest Penalty – to determine the three month interest penalty your current outstanding mortgage balance is multiplied by your current face interest rate (unless otherwise specified) and divided by 4. This is the equivalent of the interest cost for your mortgage over a three month period without factoring in any principal repayment.
For example: If your mortgage had a balance of $250,000 at 6% and we wanted to find out the three month interest penalty then we would simply multiply $250,000 x 6% = $15,000 and then divide this by four to arrive at $3,750.
Interest Rate Differential Penalty– in this case the bank is trying to recover the lost interest revenue as a result of you paying out your mortgage. This usually means the difference between the interest rate on your mortgage contract compared to the rate at which the lending institution can re-lend the money today based on a comparable term. By comparable term the bank is referring to the rate on the product which most closely matches your period of time outstanding on the initial mortgage agreement. As an example, if you were two years into a five year fixed rate mortgage then they would compare your face rate of interest with the rate of interest they would get today on a three year fixed rate mortgage because there are three years remaining in your existing contract with the bank. The goal is for the bank to subtract the rate of the comparable term from the rate of your current mortgage and then calculate the lost interest to them when the contract is broken.
As above, at a balance of $250,000 at 6% and you have 2 years in your current mortgage agreement left then they would compare this to the current 2 year mortgage rate. If this rate was 4% then the lending institution can charge you – $250,000 X 2 years X 2% (6% – 4%) or $10,000. In this example the bank would use the interest rate differential cost as this amount exceeds the cost of a three month interest penalty. While this amount is significant there are a few ways you can work to avoid or minimize it to some extent.
At a minimum, to save money you should try to find a way to come up with the amount of money that you are allowed to pay off without penalty as part of your pre-payment privileges in your contract. If this was 20% of the original balance then you would save a minimum of 20% off the penalty amount. If you were selling this home and not buying another then this may be one of the only ways to reduce the amount payable. If you were getting another home then you could look into porting the mortgage to the new property, and if increasing the mortgage amount ask to have your old rate blended with the new lower rate. If you are refinancing then the strategy above could be used in combination with the promise of keeping the mortgage with the current lender may be something to consider.
What is most important in the final course of action is the accurate and thorough review of the real cost to you to stay with the current lender, done by yourself or a trusted third party, as compared to the savings of any other mortgage option from the hundreds of mortgage providers in the market. As a point of principal I suggest you leave any lender that was unwilling to make some concession on the penalty cost as they are not showing any commitment to you. In the interest of saving your after tax dollars, the decision to leave that bank, port the current mortgage, blend the current rate with the new, or refinance (there or elsewhere) is a decision that should be based on what saves you the most amount of money. By taking the time to objectively evaluate the availability and cost of all the options you will end up with the outcome that benefits the most important shareholder of all – you!