Breaking a Canadian Mortgage Contract

One of the most stressful details associated with signing a mortgage contract is making sure you understand all the penalties, especially when it comes to prepayment or breaking your contract early. If you don’t bother to either ask the right questions or have the legal fine print explained to you, you could end up spending a lot more money than you ever wanted to.

How Does a Mortgage Contract Work? 

When you sign a mortgage contract, you agree to make payments for a certain amount of time. This is called a term, which is typically 5 years (not to be confused with the amortization period). When those 5 years are up you’ll go back to your mortgage lender and agree to another term. When you break your mortgage contract early it means that you want to stop making your agreed upon regular payments before your term is up. 

Learn more about your mortgage payment options.

Good Reasons to Break Your Mortgage Contract Early

There are a number of reasons why someone may want to break their contract early. Generally speaking, people usually break their mortgage contacts because:

• They’ve found a lower interest rate with a different mortgage lender
• They need to sell their house
• They want to refinance their mortgage
• Their credit has improved and can now qualify for a better rate or term
• Their finances have changed

Breaking Your Mortgage Contract

While most people don’t think about breaking their mortgages before they even have one, it’s still very important that you understand the consequences of breaking your mortgage before you sign on the dotted line. Moreover, you should understand the options available to break your mortgage.

Two Options When Breaking Your Mortgage Contract

• Early renewal option: Blend-and-extend
• Break your mortgage contract to change lenders

Early Renewal Option: Blend-and-Extend

The early renewal option: blend-and-extend involves extending the length of your mortgage before the end of your term. This option allows you to blend your old interest with your new one so that you come up with a rate that is somewhere between your current and the new mortgage rate. This option is often better than switching lenders as you’re able to avoid the prepayment penalty fees. This is due to the fact that you aren’t completely breaking your mortgage contract with your lender.  

For example, let’s say you have 3 years left on a five year fixed rate term. Your current interest rate is 5% but your lender is willing to offer you 3% now.  Instead of refinancing your mortgage with the 3$ interest rate, you’ll get a new blended interest rate that ranges between 5% and 3%. As for your term, it would be extended back to 5 years.

Switching Lenders

The most common way Canadians break their mortgage is by switching lenders. The main reason for the switch is to secure a rate that is lower than what they currently have. Breaking your contract to switch lenders means you’ll be able to renegotiate your mortgage for a lower rate and terms that better suit your financial situation. However, by breaking your contract early, you’ll be subject to hefty fees and penalties.  Be sure to evaluate the costs involved to see if you’ll actually save on interest. 

Costs of Breaking Your Mortgage Contract

When you break a mortgage contract you’re required to pay your lender a pre-payment penalty as well as other fees such as an administration fee, an appraisal fee, and a reinvestment fee. If you plan on switching lenders may also need to pay a fee to register your current mortgage to a new one. 

In terms of the prepayment penalty, the amount you’ll have to pay depends on a few different variables. Whether you have a fixed-rate mortgage or a variable rate mortgage is probably the largest contributor to the penalty you’ll be charged when you break your mortgage contract.

Fixed-Rate

Unfortunately, trying to figure out what you’ll be charged for breaking a mortgage with a fixed rate is very difficult and often leads to homeowners miscalculating the cost of their penalty. This is why we recommend that if you have a fixed-rate mortgage and you need to break your contract for whatever reason you speak with your lender or mortgage broker directly. That being said, your prepayment penalty will be the higher of these two prepayment penalty fee calculations: 

• Interest Rate Differential (IRD) – The IRD compensates your lender for the interest they are losing out on because you’re breaking your mortgage early. This is calculated by finding the difference between the amount of interest you’d be paying on your current term for both rates. However, it is important to note that Interest rates fluctuate; therefore the interest rate you were given when you signed your mortgage contract may not be the same as the interest rate your lender could charge now.
• 3 Months Interest – As the name explains, this prepayment penalty fee is based on the amount of interest you’d pay in 3-months. 

Variable Rate

The penalty you’ll be charged for breaking a variable rate mortgage is both significantly lower and easier to calculate. Unlike a fixed-rate mortgage, your penalty fee will always amount to 3-months worth of interest. Keep in mind though that all mortgage lenders calculate their penalties with their own equations, so while you can expect to pay 3-month interest, you should also expect some variation in cost.

Find you if your should refinance or get a second mortgage. 

Pros and Cons of Breaking a Mortgage Contract Early

Pros

• You have the opportunity to secure a lower interest rate which in turn, can lead to thousands of dollars in savings. 
• You can change your mortgage terms to better suit your financial situation. 
• By securing a lower rate, you may be able to pay off your mortgage earlier if you keep your payments the same (or higher). 

Cons

• Breaking a mortgage contract early means incurring high fees and prepayment penalties that can offset the savings in interest from a lower interest rate. 
• In order to qualify for a new interest rate, you’ll need to undergo the stress test again.  
• Those planning on selling their home soon, aren’t likely to benefit from the low-interest savings.

Additional Reading

How to Budget Properly and Save Efficiently For a Mortgage

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Second Mortgage Rates

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How To Avoid The Mortgage Stress Test

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Looking for More Information on Mortgages and Mortgage Rates?

Signing a mortgage contract is often the first and the largest financial decision that an average Canadian will make, understanding fully all of the details and conditions is one of the best steps you can take to assure that no hidden issues pop up later.

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.