Mortgage Penalties Debunked: How Much will it Cost to Break my Mortgage?
One of the questions we hear most is - when should I break my current mortgage to get a better rate? Yes, the grass is always greener on the other side (especially when it seems like everyone has a better rate than you do). But when it comes to your mortgage, it’s best to weigh out the costs first to determine if it’s worth it.
Breaking your Mortgage
A mortgage agreement is a contract that comes with a commitment, however, like many contracts, there is an out clause. But, if you want to terminate that agreement early – it comes at a price. Your lender will charge you a penalty to make up for the interest they’re losing and have already, ahem, “banked” on collecting.
To determine the exact fee you’ll be charged, you should contact your lender and get them to calculate the precise figure. There are also tools available to help you calculate the approximate penalty.
How Much is my Mortgage Penalty?
While some mortgages may have a preset fee built into the agreement for breaking it, generally the fee is calculated based on either three months' worth of interest payments, or the interest rate differential (IRD), depending on if you have either a variable or fixed mortgage.
Interest Rate Differential (IRD): the difference between your original interest rate and the current interest rate charged if the lender was loaning the funds out today for the rest of the term.
Penalty for Variable Mortgage Rate
Generally, pay three months' worth of interest payments.
Penalty for Fixed Mortgage Rate
Pay whichever value is greater between three months of interest, and the IRD.
Example: How to Determine if it’s Worth It
So - how do you determine if it’s worth it to break your mortgage early? Calculate the cost and compare it to the savings. This can get a bit tricky, so we’re going to use an example to walk you through how to calculate this.
Let’s say that you were considering switching to 3.5% from 5.5% - would it be worth it? Let’s also say in this example I have a fixed rate.
Principle Balance = $100,000
Your Current Mortgage Rate = 5.5%
New Mortgage Rate = 3.5%
Remaining Months in Mortgage Term = 24 Months
Amortization Period = 10 Years
Principal Balance: the remaining balance of a loan, excluding interest.
Skip steps one and two by using a Penalty Calculator that calculates the IRD (Interest Rate Differential) and the three-month interest for you. Calculate Mortgage Penalty Now >
(..and then skip down to Step Three.)
Step One: Calculate your IRD (Interest Rate Differential)
1) Take the principal balance and multiply it by the difference between your current mortgage rate, and the new mortgage rate.
= Principal Balance x (Your Current Mortgage Rate – New Mortgage Rate)
= $100,000 x (5.5% - 3.5%)
2) Divide that number by 12.
= $2,000 / 12
3) Multiply that number by the remaining months in your mortgage term to get the approximate IRD payment owed:
= $166.67 x Remaining Months in Mortgage Term
= $166.67 x 24
Therefore the Interest Rate Differential (IRD) would be $4,000.
Step Two: Calculate Three Months of Interest
= (Your Mortgage Rate / 12 ) x Principal Balance x 3
= (5.5% / 12 ) x $100,000 x 3
Step Three: Determine the Penalty you Would Pay
Since you’re in a fixed rate you would pay the greater of the IRD ($4,000), or three months of interest ($1,375). If you were in a variable rate, you would pay three months of interest.
In this example, the IRD is greater, so you would pay $4,000 to break your mortgage.
Step Four: Calculate Your Savings
1) Calculate Interest for your current Mortgage Rate
Determine how much interest you would pay in the next two years at your current rate using our Mortgage Calculator. In our example, you would enter:
Property Value = $100,000
Amortization Period = 10 years
Mortgage Rate = 5.5%
In the Amortization Schedule, add up the Interest Column for next two years (the years you have left in your current mortgage term).
= $5,247.01 + $4,815.50
2) Calculate Interest for your new Mortgage Rate
Again, using our Mortgage Calculator, in our example you would enter:
Property Value = $100,000
Amortization Period = 10 years Current
Mortgage Rate = 3.5%
In the Amortization Schedule, you would then add up the next two years (the years you have left in your current mortgage term).
= $3,340.04 + $3,039.51
3) Calculate your Savings
Subtract the interest you would pay with your current mortgage rate from the interest you would pay with the new mortgage rate to calculate your savings. In our example:
= (Interest from Current Mortgage Rate - Interest from New Mortgage Rate)
= $10,062.51 - $6,379.55
Step Five: Determine if it’s Worth It
Determine if switching is worth it by comparing your costs to your savings.
In our example, the savings would be $3,682.96 and the cost would be $4,000; therefore it would not be worth switching.
As always, if you’re considering terminating your mortgage early or switching mortgages it’s best to speak to a mortgage specialist before making any final decisions. They can tell you if and when it makes sense to break a mortgage, without breaking the bank.