Do you have a mortgage? So do I! Looks like we have something in common. Did you know that 6 out of 10 consumers break their mortgage approximately 38 months into a 5-year term? That means 60% of people break a 5-year term mortgage well before it’s due… but do you also know what the implications are of this? Let’s take a look!

There are a variety of reasons why someone might break their mortgage term. Some of the most common include:

· Sale and purchase of a new home *without a portable mortgage
· To take equity out/refinance
· Relationship changes (ex. Marriage/Divorce)
· Health challenges or a change in required living arrangments

And this is just to name a few. So what happens when one of the above reasons or one of your own reasons forces you to break your mortgage? You have to pay a penalty. Here is an example:

Jane and John Smith have lived in their home for 2 years now. When they bought the home, they recognized that it would need some major renovations down the road, but they loved the location and the layout of the home. They were told by their parents and the bank to take a 5-year fixed term on their mortgage. They purchased it for $300,000 and have 3 years left but would like to access some of the equity in their home and refinance the mortgage to afford some of the bigger home renovations. This refinance would occur with 3 years left on their current mortgage. So, what are Jane and John looking at for cost? There are two methods that are used to calculate the penalty:

INTEREST RATE DIFFERENTIAL – POSTED RATE METHOD (used by major banks and some credit unions)
With this method, the Bank of Canada 5 year posted rate is used to calculate the penalty for Jane and John. Under this method, let’s assume that they were given a 2% discount at their bank thus giving us these numbers:

Bank of Canada Posted Rate for 5-year term: 5.14%
Bank Discount given: 2% (estimated*)
Contract Rate: 3.14%

Exiting at the 2-year mark leaves 3 years left. Now we take the bank’s 3-year posted rate of 3.44% less your discount of 2% gives you 1.44%. From there, the interest rate differential is calculated.

Contract Rate: 3.14%
LESS 3-year term rate MINUS discount: 1.44%
Interest rate differential = 1.7%
MULTIPLY that by 3 years (term remaining)
5.07% of your mortgage balance remaining. = 5.1%

For the Smith’s $300,000 mortgage, that gives them a penalty of $15,300. YIKES!

Now, if Jane and John had used their Dominion Lending Centres broker to get their mortgage, they shouldn’t be in this mess because they would have been advised to take a different product from the 5-year fixed.  However, even if they were adamant on taking the 5-year fixed, a different method would be used.

INTEREST RATE DIFFERENTIAL – PUBLISHED RATE METHOD (used by broker lenders and most credit unions)

This method uses the lender published rates, which are generally much more in tune with what you will see on lender websites (and are generally much more reasonable). Here is the breakdown using this method:

Rate when you initially signed: 3.24%
Published Rate: 3.54%
Time left on contract: 3 years

To calculate the interest rate differential on the remaining term left in the mortgage, the broker would do as follows:

Rate when you initially signed: 3.24%
LESS Published Rate: 3.54%
Interest rate differential = 0.3%
MULTIPLE that by 3 years (term remaining)
0.90% of your mortgage balance

That would mean that the Smith’s would have a penalty of $2,700 on their $300,000 mortgage.

A much more favourable and workable outcome! Keep in mind with the above example that it works only if the borrower has:
· Good credit
· Documented income
· Normal residential type property
· Fixed rate mortgage

For Variable rates mortgages, the penalty will generally be a simple 3 months interest (no IRD applies).  If you know that you’re going to break your term at some point, this is one of your best options.

If you find yourself in one of the scenarios that we listed at the start of this blog or if you just need to get out of your mortgage early, review your options with a DLC Broker! In the example above, it would have saved them at least $12,600 to work with a broker! It really does pay to have a Mortgage Broker working with you.