One of the most stressful details associated with signing a mortgage contract is to make sure you understand all the penalties, especially with regard to prepayments and termination of the contract. If you do not bother to ask the right questions or have the protection policy explained to you, you may have to spend a lot more than you expect. By signing a mortgage agreement, you agree to make payments for a given period, a so-called term, which usually lasts 5 years (not to be confused with the amortization period). Once these 5 years have passed, you go back to your mortgage lender and review a new contract with him. When you break your mortgage agreement earlier than expected, it means that you want to stop making your scheduled regular payments before the end of your term. In general, people break their mortgage contract for a variety of reasons:
- They found a better interest rate elsewhere
- They need to sell their house
- They want to refinance their mortgage
When you break a mortgage contract, you must pay a penalty to your lender. The amount you will pay depends on a few factors.
What type of mortgage do you have?
Whether you have a fixed rate mortgage or a variable rate mortgage is the factor that will most affect the penalty you will have to pay by breaking your mortgage.
Unfortunately, trying to understand the penalty of breaking a fixed rate mortgage contract can be difficult and lead to bad calculations on your part. That’s why we recommend discussing with your lender before breaking your contract if you have a fixed rate mortgage. That said, here’s what you should expect. You will be charged what is called the IDF or en ais differential interest. This penalty covers the interest your lender loses when you break the contract. As mentioned above, this penalty is complicated to calculate but in general, the FDI you will have to pay is the difference between your current interest rate and the interest rate your lender can now charge with the same amount mortgage. Interest rates fluctuate; so the interest rate you have since signing your mortgage agreement may be different from the rate your lender could charge you now.
The penalty you will have in breaking your variable rate mortgage contract is much lower and easier to calculate. Your penalty will be worth 3 months of interest. Remember that all mortgage lenders calculate their penalties with their own equations; while you pay only 3 months of interest, expect some cost variations.
Preparing to break your mortgage contract
While most people do not even think of breaking their mortgage contract before they even have a mortgage, it is very important to understand the consequences of breaking a mortgage contract before sealing your signature. Life is unpredictable and you may have to break your mortgage contract before the end of your term.
Here are the 5 most important questions about breaking a mortgage contract to ask your lender before your transaction is finalized.
1. Can I break my fixed rate mortgage before the end of the contract?
This question is important to ask as there are more and more “uncomplicated” mortgages that appear. Lenders are beginning to offer mortgages that allow borrowers to break their contracts under certain conditions, and it is important for you to know what mortgage you will acquire before signing your contract.
2. Is it possible to increase my mortgage (borrow more) without receiving a penalty?
You may decide to renovate your house along the way or simply add money to cover unexpected costs.
3. If I decide to break my mortgage contract but want to keep the same lender, do you offer a discount on the penalty?
Not all lenders offer this kind of encouragement, but some are willing to forgive the contract break or reduce your penalty if you break it but stay with them.
4. Should I pay an FDI if I break the contract of my floating rate mortgage?
As mentioned above, the penalty for breach of contract of a floating rate mortgage is generally the equivalent of 3 months of interest, but there are unconventional lenders who charge the FDI, the penalty of a breach of a fixed rate contract.
5. After a break in the fixed rate contract, will you give me a proportional penalty and if so for how long?
If you try to break a fixed rate mortgage while interest rates go down, your penalty will be affected, having a quote will allow you to weigh your options and make an appropriate budget.
Looking for more information on mortgages and mortgage rates?
Signing a mortgage contract is often the first and biggest decision the average Canadian will make; understanding all the details and conditions is one of the biggest steps you can take to make sure there are no hidden issues that will come up later.
Feel free to contact us if you feel confused about mortgages and mortgage interest rates in Canada. One of our mortgage specialists will answer all your questions.