Don’t let your mortgage break you

Everyone wants to focus on the interest rate, but that’s only part of the story.

What’s the rest of the story then?

Most Canadians choose a five-year mortgage, and the majority of them are broken in under four years. When you break your mortgage early, there are fees. These fees can vary from not-so-bad to really shockingly bad.

Here’s what you need to know about breaking your mortgage:

There are many reasons why mortgages get broken, but some of the most common reasons are:

1. Upsizing your home because you need more space
2. Downsizing after the kids have moved out or because of a divorce
3. Refinancing loans, credit cards or other debts using your home equity

We recently saw a case where a couple had around $30,000 in credit card debt costing over 20% interest, and home equity that they could borrow against at roughly 3% interest. Typically in this scenario, the no-brainer solution would be to pay off the cards using home equity and save thousands of dollars in interest fees. However in this case, the mortgage breakage fee was well over $11,000, which means that particular strategy no longer made sense for their situation.

Refinancing would have reduced the couple’s bills by around $400/month, but now they’re stuck with higher monthly payments until their mortgage matures two years down the road.

A good recommendation is going into your mortgage with the expectation that you will break it early. If you don’t understand the terms and conditions, your mortgage could break you instead.

Some of the most common reasons are:

1. Choose a variable rate mortgage

Historically, variable rate mortgages have been cheaper than fixed rate mortgages for decades. They also usually have lower breakage fees. When you break a variable rate mortgage, the penalty is generally equal to three months’ interest. On an average mortgage, that might add up to a few thousand dollars.

Fixed rate mortgages, on the other hand, often use a calculation called an Interest Rate Differential to figure out how much you have to pay to break it. It’s a complex formula involving your actual interest rate, the posted interest rate at the time you took out your mortgage, the remaining term, and other stuff. You basically need an actuary to understand it, and the final result can range from somewhere close to three months’ interest to well into the tens of thousands of dollars.

Believe it or not, we’ve come across a $16,000 fee to break a $280,000 fixed rate mortgage. That’s significantly more than the realtor’s sales commission.

2. If you must go fixed, keep the term short

Despite the historic cost savings of a variable rate mortgage, some folks simply need a fixed rate mortgage to quell their fears of rising interest rates. If this is you, one way to protect yourself from cataclysmic breakage fees is to choose a shorter mortgage term. Instead of the usual five-year mortgage, choose three years or even a single year.

Shorter terms will usually have lower rates, and you’ll also be a lot less likely to break your mortgage early and trigger fees.

3. Read the fine print (with expert help)

Always know what you’re getting into before signing your mortgage contract. Be extra cautious when dealing with the big banks – they only sell their own brand of mortgage, and they usually have the highest fees and strictest terms. Independent mortgage brokers might be the best place to start, since they can offer all kinds of mortgages, including traditional banks and independent lenders.

So there you have it. Mortgage breakage fees are terrible, awful things. Some say charging them is one of the most profitable things the bank does to Canadians. They’re also something most people don’t really know about – until it breaks them.