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Make Sure Mortgage Math Is in Your Favour
The savings need to be greater than the sum of breakage fees
Despite early predictions that mortgage interest rates were going to increase, mortgage interest rates have slid downward since last fall and winter. And although the Bank of Canada just announced they are holding the interest rate, mortgage rates could fall again in the not-too-distant future amidst trade war tensions and the need to boost the Canadian economy. So, stay tuned.
Lower rates are good for current home buyers, but if you’re like my fiancé and me, having bought in the dead of winter last year, you paid a much higher mortgage rate than what’s currently being offered. Now we’re seriously considering breaking our current mortgage contract and signing a new one at a lower rate. Most mortgage contracts can be broken but at a cost. Here’s what needs to be considered before breaking your mortgage.
The rationale should make sense: There are typically three reasons people break their current mortgage contract. First, rates have gone down and there is an opportunity to save money, as is the case with my current mortgage contract. Second, your financial situation has changed and perhaps you require lower payments or can afford to pay extra or you might simply want greater flexibility in your contract. Third, you are moving to a new home. Other reasons may exist, but they need to make financial sense.
The math needs to be in your favour: Unless your mortgage term is up and you are in a renewal period with your current lender, breaking a mortgage has financial consequences, commonly known as break fees, that are clearly described in the fine print of your mortgage contract. Most people don’t read these details, but it’s worth the effort in case you need to break your contract.
Your mortgage break fee is calculated using a variety of factors, such as how much time is left on your contract and the interest rate differential between your contracted rate and the posted rate, which doesn’t include discounts. Many lenders follow the three-month rule where the interest that would have been charged over the next three months makes up the fee. But each lender has its own method of calculation.
Other fees may also be charged, such as an administration fee, fees to remove the mortgage and potentially register a new one, appraisal or reinvestment fees.
Not surprisingly, these fees can add up to many thousands of dollars, and sometimes tens of thousands of dollars, depending on how large your mortgage balance is. So, if you choose to break your mortgage in an effort to save money on interest, the savings need to be greater than the sum of all the fees. For example, if your fees total $5,000, but your savings (after fees) are $6,000, that’s a good deal. If you don’t stand to save anything after the fees are paid, it’s not worth breaking the current contract.
Get to the bottom of what you stand to save: Not everyone has the time, or mathematical confidence, to calculate their total costs of breaking their current mortgage, which is where a deeper investigation fits in.
Call your current lender and ask them to prepare a report on the total costs to break your mortgage. Then, I would recommend working with a mortgage broker to prepare a variety of mortgage comparisons, with different lenders, where you can see the potential savings after all the fees are paid, of switching your mortgage to a new contract at a lower rate.
For a greater understanding of the math involved, check out the federal government’s Breaking Your Mortgage information page.
For my fiancé and me, we are down to two final mortgage offers that our broker has presented us with, and we’re negotiating the rates even further. Ultimately, we’ll choose the mortgage that saves us the most money and gives us the greatest flexibility to make prepayments when we have extra money kicking around. We plan to funnel this savings toward our son’s RESP.
Copyright 2019. Article courtesy of the Toronto Star, Outline Financial and FSB as originally posted in the Toronto Star.