“There are only two ways a Canadian avoids paying a mortgage penalty. They either pay the mortgage to zero or they sell the property and the purchase closing date exactly matches the mortgage maturity date – that’s it."
Across hundreds and hundreds of filings, Jerome Trail, owner and broker of record at The Mortgage Trail, has never seen either of those things happen.
That's not to say some people don't end up paying off their entire mortgage, of course they do (but then they probably wouldn't be visiting a mortgage broker). But the vast majority of mortgage holders in Canada will end up paying a mortgage penalty no matter what they do to try and avoid it.
“You need to think of your exit strategy when you’re getting into it,” Trail says. Adding that not nearly enough homebuyers consider that what they're getting into – a new home – they'll almost certainly one day have to get out of as well.
The most frequent reasons for breaking a mortgage that Trail sees through his business are:
- Debt consolidation
- A change in a domestic situation (divorce, growing family, etc.)
- Work transfers
- Want/need of a second property
"The industry always throws around the quote that people break out of their mortgage right around 3 years and 9 months," Trail says. This means, if true, even with a 5-year fixed term, you're going to be hit with a penalty. “The question is, do you want it to be $4,000 or $40,000?”
One of the biggest problems when it comes to securing a mortgage that won't end up hurting you (much) in the end, is that every lender has its own set of rules. So it's incredibly important to pay attention to the details when securing your mortgage. "Don't let a half-point of interest distract you from paying a larger penalty in the end," advises Trail.
In other words, given the likelihood that you'll break your mortgage for one reason or another, saving $25-50 a month in interest isn't exactly prudent decision making if it means your mortgage penalty ends up being tens of thousands of dollars as a result.
So, how exactly are mortgage penalties calculated? That's the most
important expensive question.
Again, there are any number of mortgage options to choose from, but generally speaking, most mortgage penalties are based on either the greater amount between 3-months of your mortgage's interest or the interest rate differential (IRD).
Yes, the greater amount is what you'll be charged.
The IRD is what you need to pay attention to as it's what could end up having you pay big bucks to break your mortgage. The IRD is simply the difference between your mortgage rate and, as is the case for most lenders, the lender's posted rate.
So, in a hypothetical scenario in which a homeowner has a $500,000 left in year three of a 5-year fixed mortgage at 2.79% and the posted rate of the lender is 4.79%, the IRD is simply 2%. If that homeowner wants to break their mortgage for any reason, they could be looking at paying $20,000 (500,000 x .02 x 2 years). If the details of the mortgage agreement aren't in your favour, you could end up jumping from the 3-month penalty, which in this case would be roughly $3,500, all the way up to $20,000 – just because you didn't read the fine print.
As Trail sums up quite simply, "The 3-month interest penalty is what you should always be shooting for."
And it's not hard to see why.
A client of Trail's recently sent him a frantic email after having a conversation with a neighbour who was selling their house:
A friend of mine told me his breakout fee of the mortgage was $30,000, yet mine was only $4,000. Have you heard of this!? What would my breakout fee be, in say, two years with this current one if it ever came to that?
Knowing the answer to those kinds of questions could end up saying you a lot of money.
"From the onset, people need to understand the ramifications of mortgage penalties and plan accordingly. Enter a mortgage with the idea that you're one day going to break it because you probably will."