“I see people’s eyes glaze over when I warn them about the true costs of a mortgage,” laments Ryan Baynham, Director of Mortgages at Planswell. “Everyone wants to focus on the interest rate, but that’s only part of the story.”
OK Ryan, we’re clear-eyed and ready to listen. What’s the rest of the story?
Here’s the thing. Most Canadians choose a five-year mortgage, and the majority of them are broken in under four years. I know I’ve personally broken my mortgage prior to maturity more than once. When you break your mortgage early, there are fees. These fees can vary from not-so-bad to really shockingly bad.”
Ryan says the most common reasons are:
1. Upsizing your home because you need more space
2. Downsizing after the kids have moved out or because of a divorce
3. Refinancing loans, credit cards or other debts using your home equity
“I saw a case recently where a couple had about $30,000 in credit card debt costing over 20% interest, and home equity that they could borrow against at roughly 3% interest,” recalls Ryan. “Normally, it would be a no-brainer to pay off the cards using home equity and save thousands of dollars. But in this case, the mortgage breakage fee was over $11,000, which means that strategy no longer made sense.”
Refinancing could have reduced the couple’s bills by around $400/month, but now they’re stuck with higher monthly payments until their mortgage matures two years down the road.
“I always recommend going into your mortgage with the expectation that you will break it early. If you don’t understand the terms and conditions, your mortgage could break you instead.”
Ryan says the most common reasons are:
1. Choose a variable rate mortgage
Variable rate mortgages have been cheaper than fixed rate mortgages for decades. They also usually have lower breakage fees. When you break a variable rate mortgage, the penalty is generally equal to three months’ interest. On an average mortgage, that might add up to a few thousand dollars.
Fixed rate mortgages, on the other hand, often use a calculation called an Interest Rate Differential to figure out how much you have to pay to break it. It’s a complex formula involving your actual interest rate, the posted interest rate at the time you took out your mortgage, the remaining term, and other stuff. You basically need an actuary to understand it, and the final result can range from somewhere close to three months’ interest to well into the tens of thousands of dollars.
“The worst case I remember seeing was a $16,000 fee to break a $280,000 fixed rate mortgage,” says Ryan. “That’s significantly more than the realtor’s sales commission.
2. If you must go fixed, keep the term short
Despite the historic cost savings of a variable rate mortgage, some folks simply need a fixed rate mortgage to quell their fears of rising interest rates. If this is you, one way to protect yourself from cataclysmic breakage fees is to choose a shorter mortgage term. Instead of the usual five-year mortgage, choose three years or even a single year.
Ryan says, “A shorter term will usually have a lower rate, and you’ll also be a lot less likely to break your mortgage early and trigger fees.
3. Read the fine print (with expert help)
Always know what you’re getting into before signing a mortgage contract. Be extra cautious when dealing with the big banks – they only sell their own brand of mortgage, and they usually have the highest fees and strictest terms. An independent mortgage broker might be the best place to start, since they can offer all kinds of mortgages, including traditional banks and independent lenders.
“At Planswell, we’ll shop the market to find you the best combination of rate, term, and flexibility,” says Ryan, in a rare act of shameless self-promotion. “We’ll make sure you understand what you’re signing up for so there are no surprises.”
So there you have it. Mortgage breakage fees are terrible, awful things. Some say charging them is one of the most profitable things the bank does to Canadians. They’re also something most people don’t really know about – until it breaks them.