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.
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, read more about that here). 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. 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
When you break a mortgage contract you’re required to pay your lender a penalty. The amount you’ll have to pay them depends on a few different variables.
Learn more about your mortgage payment options, here.
What Type of Mortgage do you have?
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.
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 home owners 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, here’s what you can expect. You’ll be charged what is called the IRD or Interest Rate Differential. This penalty compensates your lender for the interest they are losing out on because you’re break your mortgage early. As we said before this is quite complicated to calculate but generally speaking the IRD you’ll be charged is the discrepancy between your current interest rate and the interest rate your lender is now able to charge for the same amount of mortgage. 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.
The penalty you’ll be charged for breaking a variable rate mortgage is both significantly lower and easier to calculate. Your penalty will be 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.
Preparing to Break 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. Life is unpredictable and you may need to break your mortgage within the near future before your term is up.
Here are the top 5 questions you need to ask your mortgage lender, about breaking your mortgage contract, before your deal is finalized.
1. Can I break my fixed rate mortgage early?
This is important to ask as more and more “no frills” mortgages are popping up. Lenders are starting to offer mortgages that only allow borrowers to break their contracts under very specific conditions, it’s important that you know what type of mortgage you’re getting before you sign your contract.
2. Is it possible to increase my mortgage (borrow more) without being charged a penalty?
The reason you’ll want to ask this questions is because you may want to renovate your home in the future or you might simply need additional cash to cover an unexpected cost.
3. If I decide to break my mortgage but want to stay with you (the same lender) are there any penalty discounts you can offer me?
While not all lenders offer this type of incentive, some lender may be willing to forgive or reduce your penalties if you ever want to break your mortgage contract but still stay with them.
4. Will I be charged the IRD penalty if I break my variable rate mortgage?
As we discuss above, the penalty for breaking a variable rate mortgage is typically 3 months interest, but there are some unconventional lenders that charge the IRD penalty which is the penalty for breaking a fixed rate mortgage.
5.If I want to break my fixed rate mortgage will you provide me with an IRD penalty quote and if so how long will you honour it for?
If you’re trying to break a fixed rate mortgage while the interest rates are dropping your penalty will be affected, having a quote will allow you to weigh your options and budget appropriately.
Interested in renewing or renegotiating your mortgage? This article is for you.
Looking for More Information on Mortgages and Mortgage Rates?
Signing a mortgage contract is often the first and the largest financial decisions 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.
If you’re confused or have questions about mortgages or mortgage interest rates in Canada get in contact with us today, one of our mortgage specialists can help answer all your questions.