In Canada, financial institutions offer many types of mortgages, including closed and open-term mortgages. While open-term mortgages allow flexibility to borrowers to exit without penalty (only per diem interest payable), most borrowers in Canada have some form of a closed mortgage, likely due to choosing the most attractive rates at the time of first getting the mortgage or renewing. If you have a traditional 1-5 year fixed or variable rate mortgage with any A or B bank, chances are, you have a closed mortgage which yields a penalty if broken early.
It’s less common to see a mortgage term to its’ maturity these days. Some common reasons for breaking your mortgage early could be any of the following:
Selling your home
Paying off your mortgage balance in full
Refinance your mortgage (pull out equity, lock in a better rate with a different bank, etc.)
Removing an existing title holder (including a buyout)
Re-amortize your mortgage to lower payments
A fallout with your existing bank – switch to a competing bank for better treatment/products
What is the Penalty for Breaking a Mortgage in Canada?
So, exactly how much does it cost to break a mortgage early? On the institutional level, most banks and lenders have the following penalty clauses: Either 3 Months of Interest or IRD (Interest Rate Differential). Which penalty type is charged has a lot to do with the type of mortgage you have – Variable or Fixed.
Variable Mortgage Penalty: Unlike fixed mortgages, variable rate mortgages come with 1 penalty clause. The penalty for breaking a mortgage on a variable term will be a 3-month interest penalty at any time throughout the term. This is a clause that attracts borrowers to variable rates (aside from the lower rate to begin with).
To calculate the cost to break a variable mortgage, use this formula
Penalty to Break Mortgage = (Interest Rate x Mortgage Balance) ÷ 12 x 3 Months
Fixed Mortgage Penalty: The fixed mortgage penalty is a bit trickier to determine. While it can also be a 3-month interest penalty, for fixed rates, it’s the higher of the two penalty types. This means you’ll need to do both calculations to determine which penalty applies. Your penalty amount will depend on WHEN you break the mortgage throughout the term and WHAT current market rates are when you break. We discussed the 3-month interest penalty formula above. With interest rate differential (IRD), that penalty is calculated by subtracting the current market rate from the rate you are paying. The difference is multiplied against your outstanding mortgage balance (divided by 12 to get the monthly amount). Finally, using that monthly amount calculated, you will multiply once more with the number of months you have remaining on your term! Here is the formula.
Penalty to Break Mortgage = (Your interest rate – Current market rate) x Mortgage balance outstanding) ÷ 12 x the number of months you have left on your term.
Are there calculators to determine the mortgage breaking penalty?
Yes – Most institutions have some form of a ‘mortgage pre-payment calculator’ on their website to help borrowers determine the cost to break a mortgage at any time. You’ll need to be familiar with what the current mortgage rates are (should you need to calculate the penalty to break a fixed mortgage). These too can be found online at any time.
Can I avoid paying a penalty to break a mortgage?
In some instances, reducing or avoiding a penalty to break a mortgage can be achieved just by knowing what options your contract offers. Some ways to avoid a mortgage breaking penalty might be:
Port your mortgage (If you are selling and buying again, see if your mortgage can be ported to the new property instead of breaking it)
Blend and extend your mortgage (if you’re looking for more mortgage financing than you currently have, see if the bank can blend your new request with your existing mortgage to offer you the funds you need without incurring a mortgage penalty)
Mortgage assumption (if you’re selling and need to break your mortgage, can the buyers assume your mortgage instead? This would avoid a mortgage breaking penalty)
Pre-payment Privilege (Can you use your annual ‘mortgage pre-payment privilege’ to reduce the amount of the penalty to break a mortgage?)
Ask for a penalty reduction (It doesn’t hurt to ask. A penalty can be a make or break for some. Maybe you’ll catch someone on a great day. It doesn’t happen often that penalties are reduced, but under some circumstances, we’ve seen the exception.)
Want to know more about the penalty to break a mortgage in Canada? Give us a call and we’ll be happy to get more granular on this topic relative to your mortgage numbers. Let’s chat at (905) 455-5005.