For many people, a mortgage is the largest financial commitment they’ll make in their lifetime. When you take out a mortgage, you enter into a contract with your lender to make regular payments over a specified term. However, circumstances can change, and you may find yourself considering breaking your mortgage contract early.
Whether you’re looking to take advantage of lower interest rates, access your home equity, or simply want to sell your home, breaking your mortgage can come with significant penalties. Understanding the consequences of breaking your mortgage contract early can help you make an informed decision and avoid any unexpected surprises down the road. Let’s first understand the types of mortgages available when looking to finance a house property.
Closed vs. Open Mortgages
When you’re getting a mortgage, you have two main options: closed or open. Each type of mortgage has its own advantages and disadvantages, so it’s important to choose the one that’s right for you.
Closed Mortgages
Closed mortgages offer lower interest rates than open mortgages, but they come with more restrictions. With a closed mortgage, you can only make prepayments up to a certain amount each year without incurring penalties. If you want to break your mortgage contract early, you’ll likely have to pay a significant penalty.
Open Mortgages
Open mortgages have higher interest rates than closed mortgages, but they offer more flexibility. With an open mortgage, you can make extra payments or pay off your mortgage in full at any time without penalty. This can be beneficial if you’re planning on selling your home in the near future or want the option to pay off your mortgage sooner.
Which Mortgage Is Right for You?
The best type of mortgage for you depends on your individual circumstances. If you’re planning on staying in your home for the long term and don’t anticipate any changes in your financial situation, a closed mortgage may be the better option. However, if you anticipate changes in your financial situation or plan on selling your home in the near future, an open mortgage may be the better choice.
The decision of which mortgage to choose is a personal one. It’s important to carefully consider your needs and goals before making a decision. You can also consult with a mortgage professional or financial advisor to get more information and help you choose the right mortgage for you.
Understanding the penalties of breaking your mortgage contract early
If you are considering breaking your mortgage contract early, it is important to understand the penalties that may apply. The penalties for breaking a mortgage contract early vary depending on the type of mortgage you have and the terms of your mortgage agreement.
The cost of breaking your mortgage will vary depending on the terms of your mortgage agreement. Typically, there are two types of mortgages that you can use for financing a real estate property: Variable and Fixed Rate Mortgages.
Variable Rate Mortgages
With a variable rate mortgage, the interest rate can fluctuate throughout the term of the mortgage. This means that your mortgage payments can go up or down depending on changes in the market. Variable rate mortgages are typically tied to the Bank of Canada’s prime rate, which can change based on economic conditions and the actions of the central bank.
The penalty for breaking a variable rate mortgage early is typically three months’ worth of interest payments. For example, if your monthly mortgage payment is $1,500, the penalty for breaking your mortgage early would be $4,500. This penalty is generally fixed and does not vary based on the remaining time left in your mortgage term.
Variable rate mortgages are often seen as more risky than fixed rate mortgages, as your mortgage payments can go up if interest rates rise. However, they can also be beneficial if interest rates go down, as your mortgage payments will decrease accordingly.
Fixed Rate Mortgages
A fixed-rate mortgage is a type of mortgage where the interest rate remains the same for the entire term of the mortgage, typically 5 years or more. This means that your monthly mortgage payments will also remain the same, which can provide peace of mind and make budgeting easier.
The penalty for breaking a fixed rate mortgage early is usually higher. The penalty is calculated based on the interest rate differential (IRD), which is the difference between the interest rate on your current mortgage and the interest rate that the lender can charge for a new mortgage of the same type and term.
For example, if you have a fixed-rate mortgage with a 5-year term and interest rate of 3%, and the lender’s current rate for a new mortgage with the same term is 2.5%, the IRD penalty would be calculated based on the difference of 0.5%. This penalty can be significant, especially if interest rates have dropped since you took out your mortgage.
Penalties for Other Types of Mortgages
The penalties for breaking other types of mortgages, such as balloon mortgages and interest-only mortgages, may also be higher than the penalties for breaking a variable rate or fixed rate mortgage.
Possible reasons for breaking a mortgage contract
There are a number of reasons why you may be considering breaking your mortgage contract early. Here are some of the most common reasons:
To take advantage of lower interest rates: If interest rates have dropped since you took out your mortgage, you may be able to save money by breaking your current mortgage and refinancing at a lower rate.
To access home equity: If you’ve built up equity in your home, you may be able to use it to consolidate debt, finance home renovations, or invest in other properties or investments. Breaking your mortgage can provide you with access to that equity.
To sell your home: If you need to sell your home before your mortgage term is up, you’ll need to break your mortgage contract. This is a common reason for people who are relocating or downsizing.
To switch to a different mortgage type: Some people may choose to break their mortgage contract to switch from a variable rate mortgage to a fixed rate mortgage or vice versa. This may be done to take advantage of lower rates or to get more stability in their mortgage payments.
Financial difficulties: If you’re experiencing financial difficulties, you may need to break your mortgage to reduce your monthly mortgage payments or access your equity to pay off debt.
Here are some additional things to consider before breaking your mortgage:
The length of time left on your mortgage term: The longer the time left on your mortgage term, the more likely it is that breaking your mortgage will be costly.
Your financial situation: If you’re experiencing financial difficulties, breaking your mortgage may not be the best option. The penalties for breaking your mortgage can add to your financial stress.
It’s important to note that breaking your mortgage contract early can come with significant penalties. Before making any decisions, it’s crucial to understand the terms of your mortgage agreement and the penalties that may apply. Consulting with a mortgage professional or financial advisor can help you make an informed decision that’s right for your specific situation.
