A lot can happen within the 5 years of a mortgage term.

Just ask Sarah, a high school teacher in Elliot Lake, Ontario.

Two years into a 5-year fixed term, Sarah suddenly found herself having trouble making ends meet.

“Last year, I unfortunately had to take on extra debt to pay for some unexpected and very costly home repairs,” explains Sarah. “At first, I thought I could juggle all of my monthly bills, however, I soon discovered that my finances were being stretched well beyond my comfort zone.”

But then interest rates started falling and Sarah wondered if breaking her mortgage was a possible solution.

“One of my colleagues had recently told me they were able to find significant monthly savings by consolidating all of their debt,” continues Sarah. “The only caveat is it involved breaking their mortgage, which I knew came with penalties—and being only two years into my 5-year (fixed) term, I wasn’t sure if the cost would be worth it.”

That’s when Sarah reached out to Chris Knoch of Educators Financial Group.

“I’m quite familiar with these types of situations,” says Chris, Mortgage Agent Level 1 – Director of Lending. “Sometimes, through no fault of their own, people find themselves feeling overwhelmed to the point of being unable to pay their bills. So, when Sarah contacted me, I explained a few possible scenarios to help her lessen the burden.”

One option was to break and refinance Sarah’s mortgage, including consolidating her debt.

“If Sarah increased the size of her (mortgage) loan to cover all outstanding debt, several monthly payments would become one, immediately reducing the strain on her finances,” describes Chris. “And since interest rates have fallen significantly from the rate Sarah locked in at 2 years ago (from 6.59% to 4.44% at the time of publication), the monthly savings could very well be worth the penalty of breaking her mortgage—the cost of which would get swallowed up into the new loan amount.”

But what exactly are the costs associated with breaking a mortgage?

Well, that all depends on whether you have a closed or open mortgage for starters.

Breaking a closed mortgage (which is the type of mortgage Sarah has) comes with penalties, whereas breaking an open mortgage does not.

Mortgage Type	Penalty	Pros	Cons
Closed	Yes	Tends to offer lower rates compared to open mortgages	Features a fixed term and conditions that are difficult to change/break without incurring prepayment penalties (which could come at a significant cost)
Open	No	Can make prepayments or break the mortgage without incurring any penalties	Typically has a higher interest rate to compensate for the flexibility it offers

Furthermore, the amount of penalty you’ll pay for breaking a closed mortgage will be calculated based on whether the interest rate is fixed or variable:

• Fixed: penalty is calculated using a method called the interest rate differential (IRD)
• Variable: typically involves a penalty of 3 months of interest payments

Plus, regardless of the rate, there may also be additional costs to consider when it comes to breaking a closed mortgage.

“These costs could include administrative, home appraisal, and discharge fees,” adds Chris. “Plus, if your lender offered you cash back at the beginning of the term, you might also have to repay a portion of that as well. Which is why it’s important to have your lender run all the numbers to see if the benefits of breaking your mortgage actually outweigh the costs.”

If the cost of breaking your mortgage ends up being too great, there is also another option that Chris presented to Sarah.

“That option is called a blended mortgage,” explains Chris. “This involves combining your existing mortgage rate with a new, current rate. Now keep in mind that you’d only benefit from this strategy so long as current rates were significantly lower, otherwise it wouldn’t be worthwhile. However, in Sarah’s case, with the difference being in excess of 2%, she would definitely see a reduction in her monthly mortgage payment. Also note that some lenders may require the borrowing of additional funds when going the blended route, which could actually work out in Sarah’s favour if she decided to consolidate debt.”

Types of blended mortgages:

• Blend-and-extend:where you extend the term of your mortgage while getting the new blended rate (resetting your mortgage term in the process)
• Blend-to-term:where the new blended rate only applies to the remaining term of your original mortgage

Blended benefits beyond a lower rate:

• No prepayment penalties
• You can access available equity in your home

Caveats of a blended mortgage:

• Won’t be an option if you have to sell or move to a new lender
• Might not be the best option if you’re looking to get the lowest rate available
• There may be administrative fees

So, which option did Sarah ultimately decide was right for her?

“I chose the refinance and consolidate route because I just wanted a clean break,” reveals Sarah. “Breaking my mortgage definitely wasn’t a decision I took lightly, but thanks to Chris crunching the numbers and fully explaining my options, I was able to land on a solution that helped me to make the best of a really difficult situation.”

What advice does Chris have for others faced with the prospect of breaking their mortgage?

“If you find yourself in a situation similar to Sarah, you’re not alone—reach out to Educators Financial Group,” says Chris. “From where you are on the pay grid to how close you are to retirement, there are several factors to consider—especially where education members are concerned. That’s where getting specialized advice can make all the difference.”

In summary, breaking your mortgage might be worth looking into if:

• Your financial situation has changed / become more challenging
• A divorce, death in the family, or job loss suddenly triggers the need to sell your home
• Interest rates have dropped significantly and you’re looking to capitalize on lower payments (ensuring any savings are greater than the prepayment penalty)
• You’re looking to lower your monthly payment to maximize monthly cash flow (by extending your amortization to 30 years—available on all mortgage refinances)
• You’ve come into a sudden windfall / inheritance or are starting to move up the pay grid and you find yourself in a financial situation to pay your mortgage off early

 

Reach out to one of our Mortgage Agents for educator-specific advice

 

Brokerage License 12185. O.A.C