Ensure you understand the penalties before changing your mortgage

By Geoff Kirbyson

There are few penalties as punitive as those handed out by banks and other lenders for breaking your mortgage.

They can amount to many thousands of dollars so if you’re going to pay them, experts say you better be sure you know what you’re doing.

Mortgage penalties are designed to compensate a bank or other lender for the interest payments it loses when you break a mortgage contract. And while nobody is going to hold a bake sale to help the Big Banks meet their quarterly estimates, it’s easy to see that they make sense. The lender enters into a contract with you and expects to make a consistent income each month over the term of the deal. If you break it off, they lose out on the income.

Even though you may not think you’d ever have any reason to break your mortgage, it can happen. That’s why Catherine Schellenberg, REALTOR®, recommends protecting yourself before signing off on the contract, such as making sure it’s transferable.

“If you buy a house, but your dream home comes on the market three years later, and you have two years left on your term, they’ll let you transfer the balance plus any additional financing that’s needed gets blended in, so you don’t have to take on the penalty,” she said.

This isn’t the case with every mortgage, however. For example, some of them can’t be transferred to another province.

Research has shown that about seven in 10 people adjust their five-year fixed rate mortgage before it matures, although most do it for refinancing or to move into a bigger house, rather than breaking the mortgage outright.

Mortgage penalties vary depending on what kind of product you have. If it’s a variable-rate plan, you’ll be dinged for three months’ interest. If it’s a fixed rate, the penalty is usually the higher of three months’ interest or the interest rate differential, or IRD.

Rather than wearing out the battery in your calculator, figuring out your penalty can take a few seconds if you go online and search for mortgage penalty calculators.

For example, if you took out a five-year, fixed-rate mortgage at 3.7 per cent three years ago, had $250,000 left to pay off and wanted to break it, you’d be assessed a penalty of $5,800.

That’s not small potatoes by any means but many people justify the expense by amortizing it into the rest of their new mortgage. This was pretty easy to do when mortgage rates were at historic lows a few years ago, but it can be harder to stomach with interest rates heading in the opposite direction.

Schellenberg has seen mortgage penalties range from as little as a few hundred dollars up to $18,000.

She said some people simply get tired of their home and want a different view out their front window after a few years. If they’re moving into something bigger and better, paying the penalty can make sense financially.

“I always tell my clients to talk to their bank, what does your banker have to say about this?” she said.

“I find people who make some of the worst financial decisions don’t have the money sense, they don’t have the knowledge to make the right decisions. The best thing you can do to build equity in your home is live in it. You don’t have to stay in it for 20 years but stay in it for more than two. Let the real estate cycle go through, usually an eight to 10-year time frame. By then you’ve probably done some improvements as well.”