Dropping Mortgage Rates - Great For Buyers, But Sellers Beware
We are currently seeing historically low interest rates on mortgages. This is a fantastic benefit for buyers, making their mortgage payments lower and home ownership more affordable. But when rates drop quickly it can mean significant penalties to break a fixed rate mortgage. This can have a big impact on anyone breaking their mortgage before their term ends. And while porting to a new property can allow you to get credited back for the penalty, sellers do not always have that option or they can actually save more breaking the current mortgage for a new, lower rate.
If you are selling and not buying again, refinancing, choosing not to port, or you can't meet your lenders porting requirements, the penalty will be your cost to bear. I'll explain why penalties are higher when rates drop and why a seller may need to call their lender more than once to confirm their penalty.
Dropping Rates = Higher Fixed Mortgage Penalty Calculations
When a borrower breaks a fixed rate mortgage before their term is complete, they will pay a penalty. That penalty is generally the greater of a 3-months interest charge, or an Interest Rate Differential charge (IRD). The concept behind an IRD is to charge the borrower for what the lender loses in letting them out of the mortgage early. When rates drop significantly over a short period of time, the lender loses more by letting a borrower out of their mortgage because they will fetch lower returns when they re-lend out that money again.
Example: $350,000 mortgage with a 5-year fixed term at 3.5% breaking it after 2 years
The lender looks at the rate they are charging for a 3-year fixed mortgage (because that is how much time is left in the borrower's term). Lets say their current 3-year fixed is 2.2%. The interest rate differential is 1.3% (3.5% - 2.2%).
IRD penalty = $350,000 current mortgage x 1.3% x 3 years = $13,650
3 months interest = $3,063
Penalty to break this mortgage is $13,650.
This is a simplified example and lenders do vary on how they do this calculation. Some lenders go even further and calculate in the "discount" off their posted rate you initially received, making penalties even higher.
Variable rate mortgages have a different penalty calculation. The standard penalty charged is 3 months interest, making them far less expensive to break early.
Selling? Check Your Mortgage Penalty Again
The penalty on your mortgage is always moving around based on what rates are doing and when in your term you are breaking it. So, if you called in the spring to find out what your penalty to break your mortgage would be, that penalty could be much lower now if that lenders shorter-term rates have dropped. If you are considering a sale or refinance be sure to confirm your mortgage penalty first.
Align Sale To Your Renewal Date
If you do have a high penalty charge and have an upcoming renewal, you can save thousands by selling with a possession date that falls on or after your mortgage maturity date.
If you are looking at selling, make sure you understand your options. Contact me to calculate what you'll come away with on a sale and to understand the mortgage considerations.