Does Breaking Your Mortgage Make Sense?
I had a meeting with a lady this week. She wasn’t in trouble financially, but she was concerned that if she didn’t make some changes to her financial habits, that she would be. I’m a huge advocate that you should seek help before you need it – so kudos to her for doing so.
We discussed several options and I gave her some homework on things she could do to figure out what’s working, what isn’t and then work towards a plan to reduce her dependency on credit. One of the questions she asked me was “Should I look at remortgaging?”. Her mortgage was locked in for another year and she would be faced with a penalty.
Interestingly enough, an article appeared in my inbox the next day (not that surprising to me, I notice things often appear just when I need them the most) that addressed this specific question. I am including it below as a guest post. Enjoy!
Perhaps you want to free up cash for such things as renovations, travel or putting towards your children’s education? Or maybe you want to pay down debt or pay your mortgage off faster?
In some cases, the penalty can be quite substantial if you aren’t very far into your mortgage term, but we can determine if breaking your mortgage now will benefit you long term.
People often assume the penalty for breaking a mortgage amounts to three months’ interest payments so, when they crunch the numbers, it doesn’t seem so bad. In most cases, however, the penalty is the greater of three months’ interest or the interest rate differential (IRD).
The IRD is the difference between the interest rate on your mortgage contract and today’s rate, which is the rate at which the lender can relend the money. And with rates so low these days, the IRD tends to be greater than three months’ interest. Because this is a way for banks to recuperate any losses, for some people, breaking and renegotiating at a lower rate without careful planning can mean they come out no further ahead.
Keep in mind, however, that penalties vary from lender to lender and there are different penalties for different types of mortgages. In addition, the size of your down payment and whether you opted for a “cash back” mortgage can influence penalties.
While breaking a mortgage and paying penalties based on the IRD can result in a break-even proposition in the short term, if you look at the big picture, you’ll see that the true savings are long term – as we know that rates will be higher in the years to come. Your current goal is to secure a long-term rate commitment before it’s too late, and here lies the significant future savings.