Should You Break Your Mortgage to Take Advantage of Lower Rates?
Amid the global financial chaos of the past few weeks, Canada’s major banks have been making some big changes. For the second time in 2 weeks, the Bank of Canada slashed the prime rate by 50 basis points, bringing the total rate cut to a full percentage point lower than before the global COVID-19 pandemic.
Like many homeowners, I make some fairly eye-watering mortgage payments. And like many gig economy workers, I don’t have much job security to lean on in these uncertain times. So naturally, when interest rates dropped, I wondered if there could be a way to take advantage of a lower rate on my mortgage.
My mortgage broker, Scott Brown from Ultimate Mortgage and Finance Solutions Inc., answered some of my most pressing questions.
Should I break my fixed-term mortgage to take advantage of lower rates? Should people consider switching from variable to fixed to lock in a lower rate?
In the past week, many people have been contacting their mortgage brokers about breaking their current mortgage agreements to lock in lower rates. “Things are really busy right now. I must have done around $10 million worth of mortgage breaks last week,” says Brown.
Two weeks ago, there was a big incentive to do this. By the end of last week, things have changed slightly.
In theory, a 1% lower prime rate makes it cheaper for people to borrow money for a mortgage. In reality, the numbers aren’t so simple. It’s up to the banks to decide whether or not they pass along the full amount of the lowered rate to borrowers.
Two weeks ago, we did see banks passing along the full lowered rate to borrowers. But just a few days later, we started seeing a few caveats. Many banks have also started to reduce the discounts they’re offering on their variable rate mortgages by 0.5% or more. Similarly, while fixed rates initially dipped, they’re now rising again. We are likely to see much more fluctuation in rates over the coming weeks and months.
Right now, rates are still lower than they were before the pandemic, but whether or not it’s a good idea to break your mortgage very much depends on your individual situation.
How can I calculate whether or not breaking my mortgage is worth it?
It depends on three things:
- The balance of your mortgage (i.e. how much of it you have left in your term)
- The penalties for breaking it
- The rate differential available
There are 2 types of penalties: three months interest, and loss of interest. The first is the lesser penalty, while the second can be a much larger one. Variable rate mortgages always have a three month interest penalty, whereas fixed rate mortgages take the greater of three months interest or loss of interest. You can find out more about these two types of penalties here. Big banks tend to levy steeper penalties. Brown’s advice is to call your lender to find out which one applies to you.
If you can save more than the cost of the penalty before your term ends, it’s worth considering. If you can’t, you’ll end up paying more in the long run, even with a lower interest rate.
Keep in mind, too, that posted rates aren’t necessarily reflective of the rate you’ll be offered. When you first get a mortgage, depending on your individual financial situation, it’s sometimes possible to get a lower rate than those posted. But rates for refinancing a mortgage are typically higher than posted rates. So don’t expect the same kind of deal you got initially. The rate that you will be offered also varies according to different scenarios, like whether the mortgage is insured or not, and the amortization period.
Rather than try to work it out yourself, contact your mortgage broker to find out whether it’s worth pursuing or not. If you have a variable rate mortgage, or you have a fixed mortgage and know what your penalties are, your broker can work this out in about 5 minutes.
Are there any long-term negative consequences to breaking a mortgage?
According to Brown, not really. If it makes financial sense, there’s nothing wrong with breaking a mortgage. It won’t count against you in the future and the details of any penalties paid are not reflected in credit histories.
How exactly do you break a mortgage? What does the process look like?
Breaking a mortgage means refinancing a mortgage. That involves starting a whole new application, so there’s significant time and effort involved. While some things stored on file may not have changed, like void cheques and identification documents, others require up-to-the-minute information and date stamps.
If you don’t stand to gain all that much after the penalties are factored in, it may not be worth the bureaucratic effort. If your penalties are in the region of $25-35K, Brown typically doesn’t recommend breaking your current mortgage.
Think about the time and effort you went through to get your mortgage in the first place. If you’re comfortable putting in that level of work, ask your broker to check by how much you’d come out ahead.
If I’m worried about being able to make my mortgage payments, what should I do?
In light of the global turmoil we find ourselves in, many banks are offering a 6-month deferral of mortgage payments. However, it’s not clear how interest would rack up in these cases.
If you’re worried about making your mortgage payments, Scott says contact your lender directly (not your broker) to find out if they’re offering a payment deferral option, and the details of their policy around it.
Deferring your mortgage payments may be a better option for those who are particularly cash-strapped at the moment, rather than breaking your mortgage to take advantage of lower rates.
Ultimately, I’ve chosen to stick with my current mortgage for now. But I’ll be keeping a close eye on the rates and staying in touch with my broker in the weeks and months ahead.
If you’d like to chat with Scott Brown about your individual mortgage situation, you can reach him by phone (416-428-1153) or email [email protected]