Interest rates are at an all-time low and many people have rates that are above 3%.
Those people are legitimately asking whether it is worth breaking their mortgage. They want to realize the savings associated with a lower rate. Most people decide to break their mortgages based on their sentiments. They focus on penalties involved instead of basing their decisions on facts.
When paying debt off through a mortgage, the improvement in cash flow usually justifies the costs incurred to break the mortgage. If you have a mortgage broker, they will assist you in making these calculations.
Below are steps that you can follow to determine if it is worth breaking your mortgage to save money from a rate reduction.
a. Contact your existing mortgage company to obtain your accurate mortgage balance.
b. Establish what the penalty will be to break the mortgage.
c. Find out what discharge fees to expect.
Add the above three costs together. Calculate the following for a 5 year term at the remaining amortization period:
a. New mortgage payment
b. The balance after 5 years at the new interest rate
Evaluate the savings.
From the above information there are four ways to determine whether it is worth the costs of breaking your mortgage:
1. Cash Flow:
Calculate the difference between your current mortgage payment and the potential new mortgage payment. Make sure there is a cash flow improvement. Multiply the cash flow improvement with the months remaining in the existing term. This total amount should be more or equal to the costs you incurred to break the mortgage.
2. Mortgage Balance:
You don’t know what interest rates would be at the end of your existing term. Thus you need to assume that interest rates would stay at least the same for your existing mortgage, for the next 5 years. Then calculate what your mortgage balance would be at the end of a five year term, without the costs added. If your mortgage balance at the new rate and the costs added is lower than what your existing mortgage would be at the end of a five year term, then it justifies you breaking your mortgage.
3. Improved Amortization:
Calculate the amortization period of the new mortgage with the costs added, but at your existing payment. This should reduce your amortization period over what it would be at a new payment. The months saved over your previous amortization, multiplied by the monthly payment constitutes your savings. This should provide you with justification to break your mortgage. It is also worthwhile to calculate what your mortgage balance would be at the end of the term if you kept your payment the same. It should be lower than what it would be if rates stayed the same for the current mortgage.
4. Risk Protection:
Despite the results above, some people might want to lock in a lower rate anyway. This is because of concerns about interest rate increases. The security of another 5 years at a very low rate, would supersede any reasonable costs incurred by breaking the mortgage.
From the above it can be seen that it is very important to have the right mortgage that can be broken with reasonable penalties. Lenders don’t calculate their penalties the same at all. As a result, there are many people paying much more than they should be for their mortgages. They cannot break their mortgages because of the unreasonable penalties.
83% of Canadians do end up breaking their mortgages before their term matures. We want to make sure that you have the right mortgage to begin with. It might not necessarily be the lowest rate. Set an appointment with us so that we may assist you in planning the best mortgage. We can give you the power of becoming mortgage free, faster.