Homeowners choose to break their mortgages for many reasons. In some situations, breaking a mortgage could make more financial sense than waiting for maturity. If you’re a homeowner seeking to lower your interest rates or save money, you may benefit from breaking your mortgage. Breaking your mortgage can help you take advantage of lower rates, pay off high-interest debts, fund home renovations, finance education, or a downpayment on a second home or investment property. 

There are costs associated with breaking a mortgage before the end of the term that could outweigh the advantages or realized savings. Unless you currently have an open mortgage, you will pay a penalty for breaking the mortgage before its maturity date. This post looks at breaking your mortgage, the costs and benefits, and alternative options to help you find the best solution.

Key Takeaways

• Breaking your mortgage could have a substantial penalty depending on your mortgage type and remaining term. 
• Fixed mortgages have a penalty of 3 months of interest or an interest rate differential (IRD), whichever is higher. 
• To avoid high penalty costs, consider blending and extending, porting, early renewal, or using mortgage prepayment privileges.

Are There Penalties for Breaking a Mortgage?

By signing a mortgage contract, you agree to the terms and conditions set out with your lender. Unless you have an open mortgage, if you choose to break your mortgage contract before the end of the term, you will be subject to a penalty for breaching the contract terms. As most mortgages are closed, penalties are applied based on your mortgage type and the time remaining in the term. 

If you break a fixed mortgage, the penalty is either the interest rate differential (IRD) or 3 months of interest, whichever is greater. Some restricted mortgages require you to repay a percentage of the remaining balance as a penalty for breaking the mortgage. Breaking a fixed mortgage closer to the beginning of the term means you will pay much higher penalties than if you are closer to the end. 

If you break a variable mortgage, the penalty is calculated based on 3 months of interest. It won’t matter if you have a variable or adjustable-rate mortgage or if you’re at the beginning, middle or end of your term when calculating the penalty for variable mortgages. 

Penalty Calculations for Breaking a Mortgage

The penalty for breaking your mortgage can vary significantly depending on the type of mortgage and how much time is left on the term. With open mortgages, you can break the mortgage at any point during the term without penalty. However, this flexibility typically comes with a much higher interest rate when compared to closed mortgages. 

With closed mortgages, the penalty will depend on whether the mortgage is fixed or variable. The penalty for variable and adjustable mortgages is 3 months of interest, while fixed mortgages are the greater of 3 months of interest or the interest rate differential (IRD). 

For example, you renewed your mortgage for a 5-year term with a rate of 5.95%, which you now want to break. You’re 3 years into the term with $200,000 remaining on the mortgage. Interest rates for 2-year terms are 4.34%. 

To calculate the penalty for 3 months of interest:

1. Multiply your remaining mortgage balance by your current interest rate:
   • $200,000 x 0.0595 = $11,900
2. Divide the answer from step 1 by 12 months to get a monthly amount:
   • $11,900 / 12 = $991.67
3. Multiply the answer from step 2 by 3 to determine the 3 months of interest penalty:
   • $991.67 x 3 = $2,975.01

To calculate the IRD penalty:

1. Calculate the difference between your current interest rate and the rate matching the remaining time on your mortgage term. 
   • 5.95% – 4.34% = 1.61%
2. Multiply your remaining mortgage balance by the difference in rates from step 1: 
   • $200,000 x 0.0161 = $3,220
3. Divide the answer from step 2 by 12 to get a monthly amount:
   • $3,220 / 12 = $268.33
4. Multiply the answer from step 3 by the time remaining on the mortgage term in months:
   • $268.33 x 24 = $6,439.92

In this example, if you have a fixed-rate mortgage, you would pay the IRD penalty of $6,439.92 as it’s higher than 3 months of interest. If you had a variable or adjustable-rate mortgage, you would pay the 3 months of interest penalty of $2,975.01. There may be additional fees such as legal and registration costs, mortgage discharge fees, and land title de-registration fees to consider on top of the penalty for breaking the mortgage. 

Difference Between Standard IRD and Discounted IRD

There are two ways lenders may use to calculate the IRD penalty that could significantly impact the amount of your penalty. Standard IRD calculations like the example above are used by mortgage finance companies, virtual lenders, and non-bank lenders to determine your penalty. 

Financial institutions such as banks and credit unions often use a Discounted IRD calculation to determine the penalty. This compares your current interest rate to the current posted rates minus any discount you received on your rate. This results in a significantly higher penalty, particularly for those with short-term fixed-rate mortgages. 

Let’s compare the Discounted IRD to the Standard IRD calculator from above. Assume you were offered a 1% discount from the posted rate when you renewed your mortgage. 

To calculate the Discounted IRD penalty:

1. Subtract the discount you received from the 2-year term rate:
   • 4.34% – 1% = 3.34%
2. Calculate the difference between your current rate and the rate from step 1:
   • 5.95% – 3.34% = 2.61%
3. Multiply your remaining mortgage balance by the difference in rates:
   • $200,000 x 0.0261 = $5,220
4. Divide the answer from step 3 by 12 to get a monthly amount:
   • $5,220 / 12 = $435
5. Multiply the answer from step 4 by the time remaining on the mortgage term in months:
   • $435 x 24 = $10,440

It’s crucial to understand which method your lender will use to calculate the IRD penalty, as the difference could significantly diminish any potential savings you may realize when breaking your mortgage. 

When Would I Consider Breaking My Mortgage?

It may seem like a bad idea to break your mortgage, considering the potential penalties for doing so, but there are some circumstances where doing so and paying the penalty may make sense. 

Breaking Your Mortgage Due to Lifestyle Changes

Changes to your lifestyle, like moving for a new work opportunity, expanding your family, relocating to take care of aging relatives, or a divorce or separation, may require you to break your mortgage before the end of your term. In these situations, your mortgage may no longer suit your changing lifestyle or financial situation so it may make the most sense to pay the penalty to have the freedom to move on to the next chapter of your life. 

Breaking Your Mortgage to Improve Your Financial Situation

One of the main reasons most borrowers break their mortgage is to get a better interest rate or to extend their amortization and make mortgage payments more manageable. Refinancing to extend your amortization can help lower your mortgage payments, though it will cost more interest over time. 

A slight decrease in your interest rate can result in significant savings over your mortgage term. However, if you’re breaking your mortgage for a better rate, it’s crucial to compare the penalty to the cost savings to ensure breaking your mortgage for a lower rate will provide savings once you’ve factored in the penalty.

You may also choose to break your mortgage to access the equity in your home, which can be used to consolidate high-interest debts like credit cards or personal loans. This can result in more manageable payments and interest cost savings. You can also tap into your home equity to finance other significant expenses like your children’s education, home renovations, or even a downpayment for another property.

Breaking Your Mortgage to Switch Lenders

Although you can refinance your mortgage with your current lender, you may choose to switch to a new lender instead. This may be because another lender has a more competitive rate or favourable terms, or maybe you’re unhappy with your current lender’s service. 

Blend and Extend Options

If the costs of breaking your mortgage outweigh the cost savings, you can still benefit from lower rates by opting to blend and extend your existing mortgage if possible. This involves combining your current mortgage rate with a new rate, allowing you to extend your mortgage term to save on interest costs and reduce mortgage payments. 

Calculating the Blended Interest Rate

To determine the new rate you will receive through a blend and extend, you must perform a series of calculations that combine your old rate with the new rate. For this example, you currently have a mortgage balance of $250,000 with 2 years left remaining on a 5-year fixed-rate term. To lower your mortgage payments, you also wish to extend the term back to 5 years, which will be considered in the calculation. 

• Mortgage balance: $250,000
• Your current interest rate: 5.95%
• Months until the end of the term: 24 (2 years)
• Months in the blend and extend term: 60 (5 years)
• Current interest rates for a 5-year term: 3.69%

1. Multiply your current interest rate by the months remaining on your mortgage term.
   • 5.95% x 24 = 142.8
2. Subtract the months in the new term from the months remaining on your current term.
   • 60-24 = 36
3. Multiply the current 5-year fixed rate by the difference in months from step 2.
   • 3.69% x 36 = 132.84
4. Add the results from steps 1 and 3. 
   • 142.8 + 132.84 = 275.64
5. Divide the results from step 4 by the number of months in the new term.
   • 275.64 / 60 = 4.59%

If you blend and extend the mortgage instead of breaking it and incurring penalties, you would have a blended rate of 4.59% for the next 5 years. 

Alternate Solutions to Breaking Your Mortgage

If blending and extending or breaking your mortgage are not suitable for your situation, alternative options are available. If you are selling your current property and purchasing a new one, you may be able to port your mortgage to the new property. This can help you avoid penalties and keep your current interest rate, which can be advantageous if interest rates are currently higher than your rate. 

Alternatively, you could have a potential buyer assume or take over your current mortgage. This involves the buyer assuming your original mortgage agreement and adhering to the terms and conditions. However, this poses a risk for the seller, who would have to resume mortgage payments if the buyer defaults.

If you are close to renewal, you may have the option to renew your mortgage early without incurring any penalties. Typically, you can renew your mortgage without penalty for up to 120 days before the end of your term. If you anticipate breaking your mortgage during the next term, you can opt for an open mortgage or a shorter term at renewal, which will help you reduce or eliminate penalties. 

If you are already locked into your next term and expect to break the mortgage, you have the option to use any prepayment privileges you can. As long as you stay within the prepayment limits outlined in your mortgage contract, there will be no penalties for using your prepayment privileges. This can lower the amount you owe on your mortgage and the penalty when you do need to break the mortgage. 

Tips on Reducing Mortgage Penalties

Although there may be situations where breaking your mortgage is necessary, there are some ways to reduce the penalties you will incur. If you have a mortgage with a fixed interest rate, waiting until you are closer to the end of the term will help you save on the penalty costs. The closer you are to the end of your term, the lower the penalty amount will be since you will likely pay 3 months of interest vs an interest rate differential. 

If your interest rate is lower than posted rates, you will likely pay a penalty of 3 months of interest compared to the interest rate differential. However, if you have a higher interest rate and aim to take advantage of lower rates, you are more likely to pay the IRD penalty on a fixed mortgage. 

You can reduce your outstanding mortgage balance if you have the additional cash to take advantage of prepayment privileges. The penalty calculation for breaking your mortgage will use your remaining balance, so the lower it is when it comes time to break your mortgage, the lower the penalty. 

Frequently Asked Questions

Final Thoughts 

Breaking your mortgage can come with high costs, which may outweigh the benefits, like reducing your interest rate or consolidating debts. To determine if breaking your mortgage is the best option, it’s essential to compare the potential savings against the penalties for breaking your mortgage before the end of the term. 

It’s crucial to contact your lender to learn the exact penalty calculation for breaking your mortgage so you can accurately determine if the savings are substantial enough to consider breaking your mortgage or if an alternative solution may be a better option. 

Contact our mortgage professionals today to discover the potential savings available through a mortgage renewal or refinance.