There are times when it makes good financial sense to break your mortgage early. This can include when you choose to take advantage of lower interest rates, pay down debt, renovate or even pay for your kid’s tuition. But, regardless of your reasoning, it’s important to weigh the pros and cons because you’ll be charged a penalty for cutting your mortgage term short.
Breaking your current mortgage and refinancing into a new one is definitely worthwhile when the overall savings you can achieve will outweigh the cost of the penalty you’ll have to pay for ending your mortgage contract before it reaches maturity. Keep in mind there are additional charges involved with refinancing into a new mortgage as well, including an appraisal and title search, legal fees and other administrative costs.
How much does it cost to break a mortgage early?
Payout penalty calculations differ by lender, so it’s important for your mortgage agent to review your mortgage contract and determine the potential penalty you could face.
The reason banks and other lenders charge you to break your mortgage early is that they make money from your mortgage loan, primarily through interest payments. And, if you pay out your mortgage early, you’re reducing the amount of money your lender makes. In order to offset some of these losses, lenders impose penalties.
An early payout penalty is typically either calculated as a percentage of your current outstanding mortgage amount – known as the interest rate differential (IRD) – or the equivalent of a certain number of monthly interest payments. In both scenarios, the fees can quickly add up.
It’s important to be aware of the fact that banks typically use their posted rate to calculate the penalty amount. Posted rates are typically higher than the actual interest rate borrowers can expect to receive. Other lenders, such as monolines and credit unions, base their calculations on published rates, which are generally more in line with the actual rate borrowers receive. This rate difference is often why you hear reports of bank IRD penalties costing borrowers thousands – and sometimes tens of thousands – of dollars.
Sometimes it makes the most sense to stay in your current mortgage longer in order to reduce the amount of the penalty you’ll have to pay in order to end your current mortgage term. The ideal time to take equity out of your home is during your mortgage renewal as you won’t be charged early payout fees.
Have questions about whether it’s wise for you to break your mortgage? Answers are a call or email away!