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How To Evaluate The Benefits Of Breaking Your Mortgage

Mortgage RatesWith the interest rate staying low and a monitored increase over the next couple of years, some home owners may be wandering if there is a cheaper interest rate available for them. The cost over a 25 year period can be quite significant and save you may years on your mortgage. Just 2 years ago, many were expecting the rates to go up and 2 years later it is still low. The Bank of Canada is expecting to see an increase by the end of the year but the economic turmoils around the world are making it challenging to drive the rates up. You can see the current trend from a historical perspective at CanEquity.

I have written a few post in the past about my personal experience with my mortgage and I continue to monitor the rates available as paying off my mortgage is one of my top goals to reach my Financial Freedom.

There are a few steps you must go through to evaluate the cost vs benefit of switching mortgage.

1. Your Breaking Cost

The first step of evaluating your options to break your mortgage is to understand the penalty. The easiest way is to simply ask your bank to get the official number. For most financial institutions, it tends to be 3 months of interest penalty or what is called the Interest Rate Differential (IRD); whichever is greater. If you took a term a while back at a rate above 5%, the chances are that the penalty can be high. This is why I stay away from long term fixed rate, your options to make changes become very costly and you are stuck for a long time. For the official number, you’ll have to contact your lender.

2. Your Target Interest Rate

This step could be your first step or in conjunction with your first step as your target interest rate may be what triggered your desire to break your mortgage. The target interest rate is important as all your future calculation hinder on that to really assess your savings.

Nowadays, there are many mortgage brokers that can help you. Some have strong ties to banks and some are truly independent from any financial institutions. You’ll need to contact them to find out what offers they have. Don’t forget to ask about the details on the rates since often times, you won’t know which institutions it is with. Also make sure you understand the breaking penalties of the offers.

Since all banks offer mortgage rates online, you can easily do a pass to all their website or simply leverage the work some websites are already doing to pull that information together.

Once you have data, you can negotiate. You may want to have a specific interest rate offered by the financial institution X but you want it with institution Y. Note that comparisons are often done with the ‘posted rate’ which can be negotiated down. Negotiating for a mortgage rate could be a post on its own to be honest. Make sure you pick a target rate available that you can have and be pre-approved for.

3. The Added Cost Of The Penalty

Once you have the cost of breaking your mortgage, you need to assess how much that’s really going to cost you. In most cases, you are just going to lump that back on the loan. To get an accurate value of the cost, you need to use a mortgage calculator and your target interest rate.

Your decision to refinance can have the purpose of decreasing your monthly mortgage cost or to reduce your amortization. Reducing your amortization without increasing your payments saves you money.

4. Calculate The Savings

Since your are doing a business transaction (a very personal one), you need to assess the savings to justify the cost. I have always found it difficult to assess the true cost since the terms are usually shorter than the mortgage. The easiest way I found is by ensuring your remaining amortization is always lower.

See the list of mortgage calculators provided by the Office of Consumer Affairs. The banks will usually have a mortgage calculator that you can use in their mortgage center.

Thoughts

As you will find out if you read my previous posts on mortgage, I have never finished a mortgage terms. Like investing, I monitor the rates and my options. Managing your lending costs should be as important as managing your investment – it just requires a lot less time :) Early in your mortgage is the best time to take advantage of lower rates as it has a compounded impact.

Readers: Have you broken your mortgage terms before? What do you make of today’s rates?

Image: renjith krishnan / FreeDigitalPhotos.net

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4 Responses to "How To Evaluate The Benefits Of Breaking Your Mortgage"

  1. I’ve broken a mortgage before, and it’s not fun. We paid a few thousand in fees, ouch, but we got a much, much better rate because of it.

    I hope I never have to do it again.

    It is a little frustrating that, as you say, just over two years ago “experts” were calling on rates to rise, fast, and maybe significantly. We all know how that turned out. We locked-into a term just over 3% with the pending “rise”. A great rate, but certainly we could be saving much, much more if we went variable. Never again.

    Uh, annoying!

    Great post and very nice work PIE!

  2. My wife and I were in a funny position where we would have broken even by breaking or staying put. In the end we rode it out and now have an interest only rate. There are a few little ups and downs, but we are happier with it.

  3. You have to find someone that can do the math correctly to see if you will come out ahead. 99% of the refinance calculators on the internet are inaccurate. You really have to find someone that can do the math and the logic properly.

  4. Heya i’m for the first time here. I found this website and I do find It truly helpful & it helped me out a lot.I’ve just been searching for information about this topic for a while and yours is the greatest I’ve discovered till now

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