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If you choose a 5-year fixed mortgage rate now, can you break later if rates drop?

With a break, you’ll pay a penalty. But it could be worth it.

In a hamster wheel waiting for lower mortgage rates? They’re not here yet, which means many Canadian homeowners are frustrated about buying or renewing at higher mortgage rates than they had hoped to see by now.

It’s probably an agonizing debate over a laptop of how long to lock in because 5-year rates are currently cheaper than 2- or 3-year rates. A shorter term could allow you to renew into a better rate sooner — but two or three years can seem like a long time to endure higher payments while you wait for rates to drop.

Here’s the catch for breaking your mortgage term.

It’s called pre-payment penalties. These are written into your mortgage contract to cover the lender’s costs if you terminate your contract early for any reason. You’ll need to consider the penalty involved when determining if a break for a lower rate will be worth your (mortgage) while.

Fixed-rate penalties are usually higher than variable-rate penalties.

The penalty type you face to break your term depends on your current mortgage rate type. Breaking a fixed rate (usually) incurs a higher penalty than a variable rate due to different managing costs for the lender. 

To break a fixed-rate term, you’ll pay an Interest Rate Differential (IRD) penalty or a 3-month interest charge, whichever is higher. Unless you have little time left in your term, you’ll likely pay the higher IRD penalty.

A variable-rate mortgage is cheaper to break— you’ll only pay a 3-month interest penalty. Plus, you can flip into a fixed-rate term with the same lender at any time, penalty-free (subject to current market rates and admin fees).

Even with a penalty, can you save if you break for a lower rate?

Let's look at Tom's situation to show how this scenario could play out — he asked a True North Mortgage broker for advice.

Tom took out a $100K mortgage two years ago at a 5-year fixed rate of 5.75%. He saw a rate offer of 3.99% and wondered if it made financial sense to break his current term to get that rate.

When Tom contacted his bank, he quickly realized he’d have to pay a hefty IRD penalty. His bank's current rate for calculating the penalty on his remaining three years was 4.50% (each lender uses its own IRD calculation, typically found in your mortgage fine print).

Tom’s IRD penalty came to $3,750. Over and above this penalty, with the new rate of 3.99%, he would save $1,350 by breaking his term.

Most lenders, including Tom's, allow up to $3,000 to be added to the mortgage amount, meaning Tom had to come up with an extra $750. After some deliberation and expert mortgage help, Tom opted to break his mortgage, absorb the penalty cost, and benefit from the lower rate — directing his saved amount into other investments.

While Tom's case illustrates the potential savings, every situation is unique. As a mortgage holder, you’ll need to account for factors such as your ability to pay the penalty, your mortgage size and rate type (fixed or variable), the time left in your term, and the extra monthly budget room you could have.hh

Breaking your term is not always optional.

Life happens, and you may face a move or sale that means you’ll need to break your mortgage early.

In this case, it’s best to connect with an expert mortgage broker who can check with several lenders for your best mortgage rate and fit. Maybe you can port your rate, find a lower one, or get flexible terms to help save you as much as possible despite your mortgage change.

Tom decided to use True North’s free service because their brokers are unified, salaried and non-commissioned for unbiased advice that has since saved him thousands — all with a stress-free process.

If you break your term, make sure to get your best rate.

As you can see from Tom’s example, a lower rate might help you save enough to make a break worthwhile.

A top trusted mortgage brokerage in Canada, True North Mortgage’s huge volume translates into a discount for your lowest-possible rate. And access to several lenders and products means they can source your options to ensure you get your best deal.

Don’t be a hamster, be a Tom. Get sound mortgage advice in your preferred language and choices that fit you — to get out of the wheel and save on your mortgage. Give True North a shout today.

Fast, expert mortgage advice can make the difference, saving you money and time. Contact Canada's No. 1 Mortgage Broker today.