Breaking your mortgage contract

From Financial Consumer Agency of Canada

Why break your mortgage contract

You may find that your current mortgage terms and conditions no longer meet your needs. If you want to change the terms and conditions of your mortgage contract before the end of your term, you’ll need to renegotiate your mortgage contract.

When you renegotiate your mortgage contract, you break your old mortgage contract and replace it with a new one.

You may want to break your mortgage contract, if:

  • interest rates have gone down
  • your financial situation has changed
  • you want to buy a new home and are planning on moving

There may be some significant costs to breaking your mortgage contract.

Read your mortgage contract or ask your lender if breaking your mortgage contact is an option. It is important to consider carefully all the costs and benefits involved.

Cost to break your mortgage contract

If your lender allows you to break your closed mortgage contract, you will usually have to pay a prepayment penalty.

Your lender may agree to reduce your prepayment penalty if you want to break your existing mortgage, but plan to arrange a new one with the same lender.

Before breaking your mortgage contract, find out if you’ll have to pay:

  • a prepayment penalty and, if so, how much
  • an administration fee
  • an appraisal fee
  • a reinvestment fee
  • a fee to remove a charge on your current mortgage and register a new one

You may also have to repay any cash back you received when you first got your mortgage. Cash back is an optional feature where your lender gives you a percentage of your mortgage amount in cash right away.

Early renewal option: Blend-and-extend

Some mortgage lenders may allow you to extend the length of your mortgage before the end of your term. If you choose this option, you’re not required to pay a prepayment penalty. Lenders call this early renewal option the blend-and-extend, because your old interest rate and the new term’s interest rate are blended. You may need to pay administrative fees.

Your lender must tell you how it calculates your interest rate. To find the renewal option that best suits your needs, consider all the costs involved. This includes any prepayment penalty and fees that may apply.

How to calculate a blended interest rate

This method of calculating the blended rate is simplified for illustration purposes. It doesn't include any prepayment penalties. A prepayment penalty may be blended into the new interest rate or paid when you renegotiate your mortgage.

Example: Calculate a blended interest rate

Suppose interest rates have gone down since you last signed your mortgage contract. To benefit from a lower interest rate, you’re considering breaking your mortgage contract to renegotiate a new mortgage with your existing lender.

Assume the following:

  • mortgage balance: $200,000
  • remaining amortization: 22 years
  • existing interest rate: 5.5%
  • months left in term: 24
  • today’s interest rate for a 5-year term from current lender: 4.0%
  • existing term: 5 years or 60 months
  • payment frequency: monthly

Table 1: Calculate your new blended interest rate
Steps to calculate a blended interest rate Example Enter your information
Step 3: multiply today’s interest rate by the difference between the number of months of the new term and the number of months remaining on your current term 4% x 36 months = 144
Step 4: add the results of Step 1 and Step 3 132 + 144 = 276
Step 5: divide the results of Step 4 by the number of months in the new term 276 / 60 = 4.6
Step 1: multiply your current interest rate by the number of months remaining on your current term 5.5% x 24 months = 132
Step 2: subtract the number of months of the new term from the number of months remaining on your current term 60 months – 24 months = 36 months
If you choose the blend-and-extend option, your mortgage rate will be 4.6% for the next 60 months.

Break your mortgage contract to change lenders

You may decide to renegotiate your mortgage contract and change lenders because another lender offers you a lower interest rate. In this case, you may need to pay a prepayment penalty to break your mortgage contract. Consider if the benefits of breaking your mortgage contract will save you money once you include prepayment penalties and administrative fees.

Example: Costs when you break your mortgage contract to change lenders

Suppose a different lender is offering you 3.75% interest. To break your mortgage contract with your current lender you’ll need to pay a prepayment penalty of $6,000.

You may also choose a blend-and-extend option with your current lender. This would give you a 4.6% interest rate.
 
Table 2: Example of costs to change lenders
Costs Current lender (using blend-and-extend option) Lender Y Lender X
Interest rate 4.6% 3.75% 3.5%
Interest you’ll pay during a new 5-year term $36,701 $34,350 $32,005
Prepayment penalty $0 $6,000 $6,000
Total cost to renegotiate your mortgage $36,701 $40,350 $38,005

In this example, you pay less when you choose a blend-and-extend option with your current lender.

Note that you’ll usually need to pay fees when you set up a new mortgage, including when you choose a blend-and-extend option. This example doesn’t take into account any fees. Lenders may be willing to pay some or all of the fees. If this is the case, your costs to renegotiate your mortgage will be less.

Pros and cons of breaking your mortgage contract

When interest rates fall, it may be tempting to break your existing mortgage and renegotiate a new one at a lower interest rate, or to blend-and-extend. Before you do, consider the pros and cons.

Pros

  • You get a lower interest rate
  • You may be able to pay off your mortgage faster if you keep your payments the same
  • You can lock in the lower interest rate for the new term of the mortgage

Cons

  • You could end up paying more in the long run because of fees and a prepayment penalty
  • If you plan on selling your home soon, you may not benefit from the potential savings of a lower interest rate

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