Break a Mortgage for a Lower Rate?

Break a mortgage for a lower rate seems like a great concept, and it usually always is. Reducing the interest rate on your mortgage, loan, line of credit, or any other credit facility will keep more money in your pocket. While a lower rate is very attractive sight and thought, it is most important to analyze all factors and costs to truly understand the math. 

Firstly, you’ll want to ascertain that you truly qualify for the interest rate that you saw being advertised. Typically rate advertisements will show starting rates, and in most cases, these rates are for insured mortgages. This means that if you are looking to purchase a property that is worth over $1M, or looking to refinance, the insured rates are not applicable. You would then need to ascertain the rate offering for what is known as a conventional mortgage.

Secondly, you must understand if you will be subjected to a prepayment penalty. In most cases, mortgage prepayment penalties are usually the greater of  3 months interest and the interest rate differential. You can easily calculate a 3-month interest penalty by multiplying the principal balance by the interest rate, and then divide this figure by 12 and then multiply by 3. 

The interest rate differential is based on your current rate, and the interest rate currently available for a new mortgage term, similar to the remaining length of your existing mortgage term. To make matters more a complicated, different mortgage lenders use different formulas to arrive at their interest rate differential penalty. The banks will usually base their calculation off of their post-rates, whereas broker friendly mortgage lenders might use their actual posted or contract rates. The latter is much more borrower-friendly. 

Say that your existing $400K mortgage bears interest at a rate of 3.14%. You verified with your existing mortgage lender that the prepayment penalty to break this mortgage will be $3,140. Now, is it worth the jump to a 5 year fixed rate mortgage at 2.69%?


$400K @ 3.14%, amortized over 25 years, over a 5 year term = $58,123.05 of interest.
$400K @ 2.69%, amortized over 25 years, over a 5 year term = $49,634.13 of interest.
=$8,488.92 savings over 5 years.
After factoring in the $3,140 prepayment penalty, say $1000 for transferring the mortgage with legal fees, you will still be ahead of the game by saving $4,348.92 over the course of 5 years. In some instances, the lender will cover some of the costs associated when you switch your mortgage. That’s money better in your pocket.
On the other hand, if your prepayment penalty and the cost of transferring mortgages proves to outweigh the interest rate savings, you have therefore saved yourself money by not proceeding.
It gets a bit more complicated in a higher-rate environment, for instance when we look at refinancing second mortgages. If you are able to reduce your second mortgage interest rate by 2%, you need to be certain that the transactional costs do not outweigh the benefit of the refinance. It might be cost-friendlier to renew the mortgage with the existing lender if origination cost outweighs the renewal cost. In some cases, you might find a need for more money, and the existing second mortgage lender is not prepared to advance you more; you will then need to refinance your second mortgage and find the cost friendliest available solution.
As always, you are welcome to contact us anytime for a no-obligation assessment.

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