Interest rates are low, and from the looks of things, should remain stable well into 2012. If you’re currently paying out the nose because you’re locked into a fixed-rate mortgage, now could be a good time to break your mortgage and refinance your rate. Unfortunately, trying to break a mortgage before your term is up can be a nightmare experience. The penalties for bailing early can be high, so don’t be rash with your decision. Consult with a mortgage broker before you dive in head first.
When Should You Break?
The decision of whether or not to break one’s mortgage boils down to simple math. When all is said and done, you want to make sure that the outstanding balance on your mortgage is less after the break. That includes factoring in any financial penalty that come with cutting ties.
Prime candidates are homeowners who took out a mortgage at a relatively high rate roughly three or four years ago. Couple that with a long amortization period and a break could help you out considerably.
Financial experts used to recommend waiting until rates dropped a minimum of two percentage points before refinancing. Nowadays, it makes sense to switch for a smaller drop. Say, for instance, that you had a five-year fixed mortgage rate of 4.0%. The current variable rate is about 2.8%. Although that’s less than two percentage points, it could potentially reduce your rate by nearly a quarter, which could translate into big monthly savings.
As such, the new rule focuses on base points. If you see a rate that’s 30 base points or more below your current rate, run the numbers. It could be worth the switch.
Breaking Up is Hard to Do
Lenders don’t like losing mortgage contracts. That’s why they impose financial penalties for breaking both fixed and variable rate agreements. Calculating the penalty for a variable rate mortgage is relatively easy. Canada’s National Housing Act mandates that this penalty can only be equivalent to three month’s interest. This will normally amount to a few thousand dollars, depending on your rate and mortgage. And while that can throw a major snag into your current budget, it could save you considerably more in interest over the lifetime of your loan.
Fixed-rate mortgages have a much higher penalty. In general, the penalty is based on the interest rate differential, or IRD. This rate is roughly defined as the difference between the rate of your current mortgage and the new, lower rate. The IRD is designed to compensate the bank for the money it loses when a homeowner opts for a lower rate. It’s a non-standard calculation, and one that the average homeowner probably won’t understand. Contact your mortgage broker for a personal assessment.
But Wait, There’s More
The process of refinancing your mortgage is a lot like taking out your first mortgage. As such, you’ll need to fill out an application and endure a credit check. You’ll also be responsible for any fees associated with the title search, inspection, or appraisal. If you’re planning to sell your home in a few years, the hassle and expense probably isn’t worth it.
Once the dust settles and your faced with your penalty, don’t freak out – you aren’t required to pay the entire penalty immediately. The outstanding amount can be added to the new mortgage balance or paid off directly depending on your financial means.
Maximize Your Benefits
Homeowners can further reduce their liabilities by opting to include other debts they may have (consumer debt or car loan payments, for example) in their newly negotiated mortgage. The combination of low interest rates and a tight credit market could be the perfect recipe for a debt-free future.