Why breaking your mortgage early for lower rates won’t save you money

A growing number of homeowners are asking about breaking mortgage early for lower rates (Getty Images)
A growing number of homeowners are asking about breaking mortgage early for lower rates (Getty Images)

Record low mortgage rates might make breaking your term early seem enticing, but the penalty costs will wipe out the potential savings.

Variable mortgage rates have fallen over the course of the COVID-19 pandemic, following a string of interest rate cuts by the Bank of Canada. Fixed rates are also lower because of market forces pushing bond yields lower. 

According to Ratehub, mortgage shoppers will find better deals on 5-year variable mortgages at around 1.6 per cent, compared to around 1.64 per cent for fixed. 

Unless you are able to renew your mortgage at more favourable rates, current homeowners are locked out of the potential savings. That leaves breaking your mortgage early.

Online mortgage agency Nesto says there’s been an increased interest in breaking early in 2020, especially in August.

“Before the pandemic, most users were sticking with their current lenders for close term renewals, while, during and after lockdown, most probably related to the market’s numerous fluctuations, they were more willing to shop around before the end of their term,” Nesto said in a new report.

“In other words, with rates at their current lows, homeowners are shopping around and willing to pay lender penalties to break their mortgages and change to lower rates for a new term.”

Penalty for breaking mortgage offset savings

By cancelling early, with new terms, a penalty will be added to mortgage payments or upfront if you prefer. That penalty, says Ratehub.ca co-founder James Laird, means it usually won’t be worth it because the penalties are so high that you won’t end up saving any money.

Based on current conditions of falling interest rates, lenders will base the penalty on an interest rate deferral.

“When rates today are lower than the rate that you’ve got in your mortgage, then that calculation turns into a large penalty. And it’s essentially designed to capture the difference between today’s rates and the rate that you have for the remainder of the term that you have,” Laird told Yahoo Finance Canada.

“So in a way, it sort of directly mimics the potential savings by definition of the way the penalty is calculated. 

Laird says he runs these numbers for consumers, and it’s always approximately a wash.

If rates were rising, the lenders would take a different approach to calculating penalties.

“In a rising rate environment. It’s just three months of interest, which is not not too bad and easy to understand, easy to calculate,” said Laird.

Jessy Bains is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jessysbains.

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