Breaking a mortgage in Canada can be a daunting decision, but sometimes, financial circumstances or personal goals change, making it necessary to break a mortgage contract before its term ends.
Whether it’s due to relocating, refinancing, or accessing equity, the decision comes with consequences — the most notable being penalties.
In this article, I’ll break down everything you need to know about the penalties for breaking a mortgage in Canada and when it might make sense to consider it.
What Does “Breaking a Mortgage” Mean?
Breaking a mortgage means terminating your mortgage contract before the end of the agreed-upon term, which typically ranges from one to five years, but can go up to ten years.
When you break your mortgage, you essentially stop making payments according to the original terms, and this comes with financial penalties.
Why Would You Break a Mortgage?
There are several reasons you might consider breaking a mortgage, including:
- Selling Your Home: If you’re moving or selling your property before your mortgage term ends, you may need to break the contract.
- Refinancing: You might want to refinance your mortgage to take advantage of lower interest rates or access equity for renovations, investments, or debt consolidation.
- Changing Lenders: Switching to another lender who offers better terms, lower rates, or more favorable conditions can also prompt the need to break a mortgage.
- Financial Changes: If you’ve experienced a significant change in your financial situation (e.g., job loss, windfall, or inheritance), breaking the mortgage might help you restructure your debt.
Mortgage Penalties in Canada
When you break a mortgage, lenders charge penalties to compensate for the interest income they lose due to the early payout. The two most common types of mortgage penalties in Canada are:
- Interest Rate Differential (IRD) Penalty:
This applies mostly to fixed-rate mortgages. The IRD penalty is calculated based on the difference between your current mortgage rate and the rate the lender can offer someone today for the remaining term of your mortgage. The longer the remaining term and the greater the rate difference, the higher the penalty will be. IRD penalties can be significant, especially when interest rates have dropped substantially since you locked in your mortgage. - Three Months’ Interest Penalty:
- This is more common with variable-rate mortgages, but some fixed-rate mortgage holders may also face this penalty. It’s calculated by taking the amount of interest you would pay over three months on your current mortgage balance. It’s generally less expensive than an IRD penalty, making variable-rate mortgages more appealing for borrowers who anticipate needing flexibility.
When to Consider Breaking a Mortgage
Breaking a mortgage isn’t always the best option. Here’s when it makes sense to consider it:
- When Interest Rates Drop Significantly
One of the most common reasons homeowners break a mortgage is to take advantage of lower interest rates. If the savings from refinancing at a lower rate outweigh the penalty you’d have to pay, it might be worth considering. For example, if the current rate is 1% or more below your current rate, it could lead to significant savings over the life of your mortgage. - To Access Home Equity
If your property has increased in value since you took out your mortgage, you might want to access some of the equity through refinancing. This can help fund major expenses such as home renovations, education, or investments. Keep in mind that you will need to assess if the cost of the penalty justifies the funds you’ll be able to access. - Financial Hardship
If you’ve experienced a significant life change, such as job loss, illness, or divorce, breaking your mortgage may allow you to adjust your financial commitments. In these cases, the flexibility gained by paying off or reducing your mortgage debt might outweigh the penalty costs. - Relocating or Upsizing
If you’re planning to sell your home and move to a new location or purchase a bigger property, you may need to break your mortgage to free up funds or negotiate new financing terms. However, before doing so, consider if you can port your mortgage (i.e., transfer it to a new property) to avoid penalties. - Debt Consolidation
Breaking a mortgage to consolidate high-interest debt, such as credit cards or personal loans, into a lower-interest mortgage might be a good financial move, especially if you’re struggling to manage multiple payments. However, ensure the penalty doesn’t negate the savings from the consolidation.
Factors to Consider Before Breaking a Mortgage
Before you decide to break your mortgage, consider the following factors:
- Penalty Amount: Calculate the exact penalty amount you’ll have to pay, whether it’s an IRD or a three-month interest penalty. Lenders are required to provide this information upon request.
- Remaining Term: If you’re near the end of your mortgage term, it might be worth waiting until renewal rather than incurring penalties. However, if rates are much lower and the remaining term is long, breaking early might be beneficial.
- Porting Your Mortgage: Some lenders allow you to transfer your existing mortgage to a new property, maintaining the same interest rate and terms. This can help you avoid penalties if you’re selling your current home but purchasing another one.
- Negotiating with Your Lender: In some cases, your lender may offer more favorable terms if you’re refinancing with them. Be sure to negotiate penalties and fees to reduce costs.
How to Break a Mortgage
- Contact Your Lender: The first step is to contact your lender to find out the exact penalty amount and any other fees associated with breaking the mortgage.
- Weigh the Costs and Benefits: Compare the penalty amount with potential savings from a lower interest rate or access to home equity. Use online mortgage penalty calculators to help make an informed decision.
- Refinance or Find New Terms: If you decide to proceed, work with your lender or a mortgage broker to find new financing terms that suit your goals.
Is Breaking a Mortgage Worth It?
Breaking a mortgage can lead to financial benefits in the long term, especially if you secure a lower interest rate or gain access to equity that improves your overall financial situation. However, it’s essential to carefully calculate the costs and ensure the benefits outweigh the penalties and fees. Consulting with a mortgage professional or financial advisor can help you make the best decision for your unique circumstances.
Conclusion
Breaking a mortgage in Canada can be a strategic move, but it comes with penalties that should be carefully evaluated. Whether you’re refinancing, accessing equity, or relocating, understanding the penalties and how they’re calculated will help you make an informed decision. Always consider your long-term financial goals and explore options like mortgage porting or negotiating better terms with your lender to minimize costs.