When is it worth it to break your mortgage?

Book Excerpt
When is it worth it to break your mortgage?
Julie Cazzin
Special to Globe and Mail Update

In this excerpt from the MoneySense Guide to Buying and Selling Your Home, a book in the "Best of MoneySense" series, writer Julie Cazzin looks at when it makes sense to break your mortgage.

Joakim Tjernell was pretty proud of himself—he’d done a damn good job of shopping for a mortgage. It was back in June of 2009 and Tjernell, a 32-year old translator, had been eyeing units in a slick modern condo building on Toronto’s Bathurst Street for a while. There was a lot of paperwork—Tjernell’s wife is a freelance graphic designer, so they had to prove that she had regular income. “This was the first time we had a mortgage, so we were nervous about getting approved,” he recalls.

But not only were they approved, their mortgage broker came through with a great offer on a variable-rate mortgage from Scotiabank. The $280,000 loan had a 25-year amortization and a floating rate of just 2.9% to start. Tjernell was sure he’d bagged a deal.

But last May he got an email newsletter from his broker suggesting that he could do even better. Tjernell thought that all variable-rate mortgages were the same, but that wasn’t the case. His original mortgage offered a rate of prime plus 40 basis points (there are 100 basis points in one percentage point). But the newsletter was offering variable-rate mortgages at prime minus 40 basis points. Was a difference of just 0.8 of a percentage point worth switching for?

When his mortgage broker ran the numbers he found out it was. Breaking his old mortgage to switch to the new one could mean a savings of more than $5,000 in interest payments over the life of Tjernell’s mortgage—enough for a nice vacation down south for him and his wife. “As soon as I realized that, I paid the $1,800 penalty, and kept the amortization period the same at 25 years,” he says. “I’m now saving $150 a month on my payments.”

If you’ve been watching rates lately, you may be wondering if you could break your mortgage to save a pile of cash too. The prime rate hit rock bottom in 2009 at 2.25% and it’s only risen slightly, to 3.0%, since then, meaning that depending on the discount you get from your lender, you can get a closed variable rate mortgage from 2.2 to 2.25%. The best available current five-year fixed rate is also a steal—it’s at about 3.8%, not far from its all-time low. (All rates were accurate as of March 2011.) Breaking your existing mortgage to switch to a lower rate could save you hundreds of dollars every month—or knock years off the length of your mortgage so you own your home sooner.

But you have to be careful. Your mortgage is probably the most complex contract you’ve ever signed. Make a wrong move and you’ll end up on the hook for penalties of $20,000 or more. The key is to run the numbers and get some advice before you approach your lender. Luckily, a quick analysis to see if you’ll come out ahead is relatively painless and free. Read on, and we’ll show you how to do it.



WHAT’S YOUR ULTIMATE GOAL?

Your first step is to decide what you want to accomplish. Most people are looking to do one of three things: to reduce the total cost of their mortgage, consolidate other debt (such as credit card debt) into their mortgage, or reduce their monthly payments, whatever the cost.

Keep in mind that lowering the cost of your mortgage can be done in two different ways. You can keep the total length of the mortgage—called the amortization period—the same and reduce each monthly payment. Or you can keep your monthly payments the same, and shave years off your amortization period so you’ll own your home outright sooner. Either way, you could save a pile of money.

WHEN IS IT WORTH BREAKING YOUR MORTGAGE?

The rule used to be that it’s worth breaking your mortgage when you can get a new rate that’s at least two percentage points lower than your current one. But that’s all changed. Because the rates are so low now, it’s worth switching for a much smaller drop. For instance, if you had a five-year fixed mortgage at 5.0% you might be eyeing the current rate of about 3.8%. That’s a difference of just over one percentage point, but it could reduce your overall interest costs by around 30% and lower each monthly payment by 15%, depending on your amortization.