Should you break your mortgage to refinance right now?

Breaking your mortgage isn't free — but sometimes the penalty pays for itself fast. Here's the math to run before you decide.

As a mortgage broker in Metro Vancouver, I often speak with homeowners who are wondering if now is the right time to refinance their mortgage. With interest rates fluctuating, it's a smart question to ask. Refinancing can be a powerful tool to save money, access equity, or adjust your financial strategy, but it often comes with a cost: breaking your existing mortgage term. So, how do you know if it's worth it? Let's break down the factors to consider.

Understanding What "Breaking Your Mortgage" Means

When you enter into a mortgage agreement, especially a closed mortgage, you're signing a contract for a specific term and interest rate. If you decide to change that contract before the term is up – whether to get a new rate, access equity, or switch lenders – you're "breaking" your mortgage. This typically incurs a prepayment penalty. Open mortgages, while offering more flexibility to break without penalty, usually come with higher interest rates to begin with.

The most common reasons people consider breaking their mortgage are:

• Lower Interest Rates: If rates have dropped significantly since you locked in, a new, lower rate could save you a substantial amount over the long run.
• Accessing Home Equity: You might want to tap into the equity you've built in your home for renovations, debt consolidation, or other investments.
• Changing Financial Situation: Life happens! A change in income, family size, or other circumstances might necessitate a different mortgage structure.
• Selling Your Home: If you're moving and can't port your existing mortgage to your new property, you'll need to break it.

Calculating the Cost of Breaking Your Mortgage

This is where the "math" comes in, and it can get a little complex, as penalties vary by lender and mortgage type.

Variable-Rate Mortgages

Fixed-Rate Mortgages

Fixed-rate mortgage penalties are typically higher and are calculated as the greater of two amounts:

1. Three months' interest: Similar to variable mortgages, this is three months of interest on your outstanding balance.
2. Interest Rate Differential (IRD): This is often the larger penalty, especially when interest rates have fallen since you originated your mortgage. The IRD compensates the lender for the interest they lose when you break your contract early.

The IRD calculation can vary between lenders, but it generally involves:

• Your remaining mortgage balance.
• Your current mortgage interest rate.
• The amount of time left in your term.
• The lender's current rate for a mortgage with a similar remaining term.

Some lenders, particularly the larger banks, use their posted rates for IRD calculations, which can result in significantly higher penalties compared to using discounted rates. It's not uncommon for IRD penalties to be in the tens of thousands of dollars.

Beyond the prepayment penalty, you might also encounter other fees, such as administration fees, appraisal fees, and mortgage discharge fees. If you received cashback when you initially got your mortgage, you might have to repay a portion of that as well.

The Mortgage Stress Test and Refinancing

Even if the numbers seem to work out in your favour, you'll need to qualify for the new mortgage. In Canada, this means passing the mortgage stress test. The stress test ensures you could still afford your mortgage payments if interest rates were to rise.

When refinancing, you'll generally need to qualify at the higher of:

• Your new contracted mortgage rate plus 2%.

This qualification applies to both insured and uninsured mortgages. It's important to remember that while the stress test determines how much you can borrow, it doesn't change your actual monthly payment.

Alternatives to Breaking Your Mortgage

Breaking your mortgage isn't always the only path. Here are a few alternatives to consider:

• Blend-and-Extend: Some lenders allow you to extend your mortgage term before it matures and blend your current interest rate with a new, lower rate. This option can help you avoid a prepayment penalty, though you might still pay administrative fees.
• Porting Your Mortgage: If you're selling your home and buying another, you might be able to "port" your existing mortgage to the new property, carrying over your current rate and terms. However, you'll typically need to re-qualify, and this option is usually only available if you're buying and selling simultaneously.
• Home Equity Line of Credit (HELOC) or Second Mortgage: If your primary goal is to access equity, a HELOC or a second mortgage might allow you to do so without breaking your first mortgage.

Special Considerations for BC Homeowners

For those of us in British Columbia, there are a few additional points to keep in mind:

• Property Transfer Tax (PTT): When you refinance, you are essentially replacing your old mortgage with a new one. While refinancing itself doesn't typically trigger Property Transfer Tax, if you are adding someone to title or making other changes that constitute a transfer of ownership, PTT could apply. PTT is a provincial tax paid when real estate changes ownership, calculated on the fair market value of the property. The rates are generally 1% on the first $200,000, 2% on the portion between $200,001 and $2 million, and 3% on the portion above $2 million. For residential properties over $3 million, an additional 2% applies to the value above $3 million.
• CMHC Insurance: If your original mortgage was insured by CMHC (Canada Mortgage and Housing Corporation) because your down payment was less than 20%, you might wonder about refinancing. CMHC Refinance can allow homeowners to access equity up to 80% loan-to-value for various purposes, including adding a secondary suite. There are also programs for premium refunds if you refinance to make energy-saving renovations.
• FHSA and RRSP Home Buyers' Plan: While not directly related to refinancing, if you're considering using funds from your FHSA (First Home Savings Account) or RRSP Home Buyers' Plan (HBP) for a down payment on a new home (which might involve breaking your current mortgage), it's worth noting that these programs can be combined. The FHSA allows tax-deductible contributions and tax-free withdrawals for a first home with no repayment required, up to $40,000. The HBP allows you to withdraw up to $60,000 from your RRSP, which must be repaid over 15 years.

Is It Worth It? Running the Numbers

Ultimately, the decision to break your mortgage comes down to a careful calculation of the costs versus the benefits.

Here's a simplified way to think about it:

1. Calculate your total penalty: Get an exact figure from your current lender. This is crucial as IRD calculations can be complex and vary.
2. Estimate your potential savings: Determine how much you would save in interest over the remaining term of your current mortgage if you

Related mortgage resources

• Explore my mortgage renewal options to review your renewal before signing.
• Explore my refinancing options to compare ways to restructure your mortgage.
• Read Surviving Mortgage Renewal Shock in Vancouver: Smart Refinancing Strategies for a related BC mortgage perspective.