Avoiding penalties for breaking your mortgage early

Mortgage penalties can be exorbitant, and some of the most extreme can hit five figures. Fortunately, homebuyers don’t have to contend with enormous penalties just to break their mortgages early – particularly since statistical data shows that the majority of borrowers do in fact break their mortgages or refinance early.  

“Internal lender statistics suggest that greater than 60% of mortgages will be paid out or restructured at an average of 36 months,” Dustan Woodhouse, DLC Canadian Mortgage Experts broker, told Canadian Mortgage Trends.

Breaking a fixed mortgage entails a penalty that is usually the greater of three-months’ interest or the interest rate differential (IRD). Regardless of how the penalty is calculated, the sum is often quite significant.

The average penalty Woodhouse sees is roughly 4.5% of the balance on a four-year fixed or longer fixed term, while the record was 7.7% with a major chartered bank on a “significant” mortgage.

“We see absolute devastation when it is 5%-down buyers in a flat or declining market that also paid a 4.15% CMHC premium, and are paying realtor fees to sell,” he said. “It is costing some of those people tens of thousands to get out of their property. And it could have been avoided.”

Being informed is a homebuyer’s greatest defence against punishing penalties down the line. “The greatest danger in our business is not unanswered questions; the greatest danger is unasked questions,” Woodhouse said.

This is when a qualified and reputable mortgage broker comes in handy, particularly for inexperienced buyers. Brokers can help prospective homebuyers find a suitable mortgage product that balances a competitive rate with the features and flexibility that are suitable for them, such as a reduced penalty should they decide to break the mortgage early.

Woodhouse added that all home loan borrowers need to be realistic about the possibility that they may move or refinance sooner than expected. This is one of the key conversations he has with his clients.

And while brokers may be able to assist homeowners after the fact, when a mortgage penalty is imminent, there is no replacing choosing a mortgage with flexible pre-payment privileges right from the beginning.

“Once the penalty is in play, there are some techniques for reduction that skilled brokers are aware of, but they rarely reduce it by more than 20%. The best strategy is knowing what you are committing to upfront.”
 

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