Do you wish to pay off your mortgage earlier than the contract provisions? Perhaps the interest rates have decreased drastically, and you want to leverage this by paying off the existing mortgage and getting a new one to save yourself from inflation. It could also be that you want to sell your property and move to a bigger one. Or, you have recently separated from your spouse, and wish to get separate mortgages.
These are valid and sometimes unavoidable reasons to break a mortgage. But what are the consequences? Read on to understand the benefits, costs and penalty for breaking a mortgage.
What Are the Penalties for Breaking a Mortgage?
Whatever the reason for breaking a mortgage is, you are likely to pay the penalty set by your lender. The penalties amounts differ depending on the basis for breaking the mortgage.
The penalties are calculated as follows:.
Variable Rate Mortgage
Variable rates mortgage means that the interest rates can change, and you are subject to repay your loan as per the current interest rates. The rates might be higher or lower than when you acquired the mortgage. Typically, you will pay a penalty of 3-months interest applied to the remaining principle. The rate of interest will depend on the lender, but it’ll usually be the lender’s prime rate or your current interest rate.
Penalty = Mortgage Balance x Interest Rate x 3-Months Interest
As the name suggests, the interest rates for fixed-rate mortgages don’t change. The penalties for breaking this kind of mortgage are a bit higher than the variable one. Also, it’s a bit complex to calculate the fines and costs for this mortgage. You may need the assistance of a broker or expert to help with the calculations.
As the name suggests, the interest rates for fixed-rate mortgages don’t change. The penalties for breaking this kind of mortgage are a bit higher than the variable one. Also, it’s a bit complex to calculate the fines and costs for this mortgage. You may need the assistance of a broker or expert to help with the calculations.to help with the calculations. Your lender may require you to repay the mortgage with a three-month interest or use an interest rate differential.
Interest rate differential = (current interest rate – current market rate) ÷ 12 months
Penalty = Interest Rate Differential x Months Remaining of Term x Mortgage Balance
How to Break a Mortgage Contract
You have several options for breaking a mortgage contract. To reduce the repayment penalties, you can take the following steps:
Understand the Mortgage Contract
Take your time to read through your mortgage contract and understand the provision. With such information, you are in a better position to go the legal way when breaking the mortgage contract..
Some mortgage contracts allow you to increase your mortgage payment amounts depending on your current financial situation without penalties. You can take advantage of this to clear your loan before the full term.
Porting Your Mortgage
Mortgage porting is a viable option for selling your property and buying a new one. This is where you repay your existing loan and then take another one using the same lender and terms, meaning you will be transporting your loan to a new property. Note that not all lenders are willing to allow this, so you have to talk to the providers first.
Turning Ownership to the Lender
Here you have to convince the lender to take over the ownership of the property to avoid foreclosure. Such arrangement is referred to as a deed in lieu of foreclosure. And to be successful, you must prove that you cannot afford to repay the mortgage.
A short sale is a suitable option to break your mortgage if your property is worth less than your mortgage balance. You convince the lender to let you sell the property and then use the proceeds to repay the loan.
When Should I Consider Breaking My Mortgage?
As earlier mentioned, some viable and unavoidable circumstances force you to repay the mortgage before the end of its term. A lot can happen between the time of signing the mortgage contract and its end that will force you to change your mind and break it. Some reasons are:
- You want to sell your property to move to a bigger one
- You are in an excellent financial position and wish to clear your loans
- Loan interest rates have dropped, so you want to take another oner
- Your family dynamics have changed
What are the Risks of Breaking Your Mortgage?
The most significant risk of breaking a mortgage is the financial burden of penalty for breaking a mortgage, especially in cases of a fixed-rate mortgage. The lender uses the IRD penalty calculator, and you may end up paying thousands of dollars.
The other risk of breaking a mortgage is you may never qualify for a mortgage under specific economic conditions. Talk to your lender or consult a broker to help you calculate interests before you decide to prepay your mortgage. Understand the risks and available alternatives to breaking a mortgage.
How Much Will it Cost to Break a Mortgage?
The cost of breaking a mortgage depends on the mortgage penalty. In cases of open mortgage, you don’t incur any charges to break the contract. On the other hand, if you have a closed mortgage, you have to pay a fee to break it, and the cost is calculated based on:
- The type of mortgage (fixed or variable)
- The amount you still owe
Nonetheless, there are still some other costs to factor in, irrespective of your mortgage type. These include the administration, discharge and appraisal fees. Also, if your lender agrees to offer you cashback, you may need to pay a fraction of it, which can result in additional costs.
How Much Can You Save From Breaking a Mortgage?
Breaking your mortgage means repaying it sooner, thus lesser interests, which is an excellent way to improve your finances. However, the amount you save depends on the cost of breaking the mortgage. For instance, the cost of breaking a fixed-rate mortgage can be pretty high, so you may end up incurring losses rather than saving money. Similarly, the reason for breaking the contract will determine if you get to save or incur more costs.
If you wish to break a mortgage because your financial situation has improved, you can clear your loan sooner and avoid the interest payments for the remaining months. But remember that you may have to pay 3-months of interest on your remaining principle. So, the higher the remaining mortgage, the higher the costs.
Now that you understand more about the mortgage penalty and costs, you can decide whether you wish to break it or wait until the finish line.