A Peek Inside the Penalty Box: Understanding Mortgage Breakage Costs

You signed up for a 3 Year mortgage, but after a year you decide to sell, or your circumstances have changed and you want to upgrade to a bigger place, or perhaps your neighbour told you about the insanely low rate they got, and you want a piece of that too.

Not a problem, right?   

Wrong.  When you sign on the dotted line for a closed term mortgage you are committing to a set term (anywhere from 6 months to 10 years) and a set rate, and if you want to sever that arrangement it’s going to cost you.

You may be thinking, y tho?  (queue up an image of the infamous y tho kid meme)

It may seem unfair but it’s actually not. The lender agreed to lend you their money at a prescribed rate of interest and they turned around and made business decisions based on that contract. If you want to end the agreement early what the mortgage penalty essentially does is recaptures the cost of what the lender would have earned on that contract if you’d stuck with it.

For example, if your fixed mortgage rate is 2.99% and you have 2 years left in your term, but you want to break the term for that new sexy 1.89% rate, then the lender is going to want you to pay the equivalent interest of 2.99% for the remaining 2 years (or some variation thereof), so you’d have to compare that penalty cost against any potential interest savings at 1.89% to see if it makes financial sense.

There are different penalty calculations and different lender policies that I won’t bore you with right now, but the bottom line is that there is always a penalty of some kind when breaking closed terms before maturity.

But I have a variable mortgage so there’s no penalty, right?

Sorry, wrong again. 

Closed terms can be fixed (a set rate) or variable (fluctuates with prime) but variable rates still have a term associated with them (usually either 3 or 5 years).  Though with variable terms the penalty is usually only 3 months interest so it can be the cheaper option to go that route if the future is uncertain for you.

What about open terms?

Absolutely, open terms exist as an option and can be a good fit for short term financing needs.  Open terms are always at higher rates of interest than closed to reflect the additional flexibility.

But what if I want an open mortgage at the discounted closed term rates?

All the benefits without any of the commitment?  Unfortunately, there is no Tinder for mortgages, so this is a hard stop no.  Why?  Because there is no incentive for the lender to offer you a discount if you’re going to be saying sayonara in the short term.  Think of it as a cell phone contract – to get the latest iPhone or free iPad with that competitive contract you’re usually agreeing to a term, and if you decide you want to get out early you’re going to get a bill for whatever is remaining on your agreement. 

The good news is that many lenders offer refinance and portability programs that provide a partial or full refund of penalty is certain conditions are met, and in some circumstances, it actually does make sense to pay the penalty and part with your contract to get that better rate, but let your broker run those numbers for you first.

And yes, there are extenuating circumstances to every situation, so if you feel your penalty was calculated unfairly or want to discuss your individual situation with the lender there is no harm in reaching out directly.

The bottom line is if you’re not going to play by the rules of the contract then you’re probably going to end up spending some time in the proverbial ‘sin bin’ when it comes to mortgage breakage costs.

Questions?  Let’s talk.