12 Apr
When Canadians buy a house, they accept that they are locked into a mortgage for up to 25 years. So, many don’t consider mortgage penalties, as they think they won’t have to cancel their mortgage in the future.
However, in life things change over time and many homeowners in Canada might have to sell their house due to moving to another city or country, sudden job loss, or downsizing. Whatever the reason may be, many Canadians have no choice but to break their mortgage, which means they are faced with paying mortgage penalties.
If you have to break your mortgage before the term is up, then be sure to review the stipulations on your mortgage contract to see how much you have to pay for the exit. Keep in mind, though, that mortgage penalties could cost you up to $10,000. Are there ways to get out of a mortgage without a penalty? First, let’s define what mortgage penalties are and then provide you with 5 tips that can lower them.
What is a mortgage penalty?
A mortgage penalty is a fee that your mortgage lender charges if you:
- Break your mortgage contract.
- Paid more than the agreed additional amount of your mortgage.
- Choose to transfer your mortgage to another lender before your term ends.
- Pay back your full mortgage amount before your term ends, which includes when you sell your house.
Since mortgage penalties can add up to thousands of dollars, be sure you understand how your lender calculates them and when you should apply to avoid further penalties.
1. Learn how to calculate mortgage penalties
A mortgage penalty is calculated based on the following criteria: interest rate differential (IRD) or 3 months’ interest. For instance, if you break your variable rate mortgage, then the mortgage penalty you might pay is 3 months of interest. So, if 50% of your $2,500 monthly mortgage payment is put towards paying interest, then you would be charged $3,750 in mortgage penalty fees, along with additional charges such as administration costs.
On the other hand, if you have a fixed rate mortgage, then your mortgage is calculated based on the IRD. The IRD is charged if you paid off your entire mortgage prior to reaching its maturity date. The IRD calculation depends on the interest rate stated in your mortgage contract. In general, the IRD is the difference between the interest on your mortgage and the amount owing on your replacement mortgage. Your lender uses IRD if your fixed rate mortgage is higher than the current interest rate and if your mortgage contract is less than 5 years old.
Here is an example of how to calculate interest rate differential (IRD):
Your bank gave you a rate for a 5-year term: 4.89%.
Your discount was 2%.
In sum, you were given a 2.89% rate on a 5-year fixed-term mortgage.
Now, you want to end your mortgage after 2 years, leaving you with 3 years out of the 5-year term. The posted rate for a 3-year term is at 3.44%. Your bank subtracts your 2% discount from the 3-year term rate at 3.44%, giving you an IRD of 1.44%. The following is how to calculate your IRD: 1.44% IRD x 3 years = 4.32% as your mortgage balance.
If your mortgage is $500,000, minus the 4.32% IRD from the $500,000, then your mortgage penalty is $21,600.
2. Blend your current mortgage to your new mortgage
If you’re planning to move to a new home in Canada, there is an option called a blend-and-extend mortgage. This happens when you add the remaining balance on your current mortgage to your new home. In this case, you do not have to break your mortgage contract and you won’t have to deal with a prepayment charge. You’re simply extending your current mortgage into your new one.
3. Reduce mortgage penalty fees with prepayments
Take advantage of prepayments because, in the long run, it lowers your mortgage loan and your mortgage penalties. Consult with your mortgage lender or advisor and be sure to bring a copy of the mortgage contract to the meeting to go over prepayment stipulations and how prepayments can affect your mortgage penalty fees if you decide to break your contract before the term is up.
4. Choose an open mortgage with a shorter term
If you know that you might have to move and sell your house before your mortgage term ends, then consider getting an open mortgage. With an open mortgage, you can pay off your entire balance during your mortgage term without facing a penalty. The main difference between an open mortgage versus a closed one is that open mortgages have a higher interest rate. However, you avoid mortgage penalty fees if you want to cancel your mortgage mid-term. If you opt for an open mortgage, then be sure to take a 1 to 2 year mortgage term.
5. Negotiate with your lender
When you want to renew your mortgage or break it, contact your lender to negotiate a better rate. Also, it’s a good idea to shop around and ask several mortgage brokers and lenders for flexible options. Before you agree to pay mortgage penalties, you should feel confident that you did your research and received various quotes.
Once you have completed your research, consult with your lender to negotiate the various quotes you received from other brokers and lenders. If your account is in good standing, your lender might agree to the lower mortgage penalty rate because they probably do not want to lose you to their competition.
Contact Us Today!
If you’re thinking of breaking your mortgage contract and want to reduce or avoid paying mortgage penalties, then our mortgage specialists are here to help. Before you decide to cancel your mortgage contract early, we invite you to talk to one of our specialists to get financially prepared on what the next steps will be. To learn more about mortgage penalties, call Mortgages Mortgages at 866-417-8805 or contact us here.