Breaking a Mortgage: Penalty, Savings and Break-Even Point
Compare the exit penalty with the actual interest savings and calculate the break-even point before breaking your mortgage.
In this article
Breaking a mortgage mid-term can be the best or the worst financial decision of the year, and it all comes down to three numbers. First the penalty: three months' interest or the rate differential, depending on the contract, an amount that moves from week to week and must be requested in writing. Then the savings: the rate gap applied to the balance, net of notary and appraisal fees. Finally the break-even point: the month when accumulated savings overtake the exit bill, to be compared honestly with how long you will actually keep the property and the loan. A prepayment privilege used before the break shrinks the penalty itself, a detail often worth hundreds of dollars. This article walks through the complete calculation, the questions to put to the lender and the situations where waiting out the term beats breaking.
Get the real penalty, in writing
The break penalty is calculated according to the contract: generally three months' interest or the rate differential, whichever is higher on a fixed rate. The differential depends on the lender's posted rates on the calculation day. Two practical consequences follow: the amount changes from week to week, and the figure quoted by phone is only an estimate. Request the detailed calculation in writing, with the formula, the rates used and the validity date. Some lenders use their posted rate rather than the rate actually granted in the differential, which inflates the bill considerably. That kind of detail shows up in the written calculation, never in the conversation.
Calculate the net saving, not the rate gap
The gap between your rate and the market's looks impressive, but the net saving decides. Multiply the gap by your balance for the gross annual saving, then subtract everything the break costs: the penalty, notary fees if you switch lenders, the appraisal and any file charges. Check whether the new lender absorbs part of these costs, and get that commitment in writing. Only the saving that survives these subtractions is real. A one-point gap on a large balance can justify a hefty penalty. The same gap on a small balance late in the amortization sometimes does not even pay the notary. Do the calculation in dollars, with your own numbers.
Shrink the penalty before breaking
The penalty is calculated on the balance, so reducing the balance before the break reduces the bill. Your prepayment privilege, often 10 to 20% of the loan per year, applies without penalty. Used the day before the break, it removes its share from the calculation. Check the annual limit, the reference period and any carry-forward of unused room: a payment in December and another in January can double the available space. Some borrowers also time the break to a maturing GIC or an expected windfall set aside for this move. Every dollar of balance removed before the calculation works twice: it cuts the penalty today and the interest afterward.
Place the break-even on your own calendar
Break-even arrives in the month when accumulated savings overtake the exit bill. To find it, divide the break's total cost by the net monthly saving. That number means nothing in the abstract. Compare it with your real calendar. If you sell or renew before the break-even, the break costs more than it saves, however good the new rate looks. A twenty-four-month break-even requires keeping the property and the loan for at least two years. A plausible move, a job transfer or a separation in progress all change the verdict. Document the full calculation, with its dates and assumptions. Two years from now, it will tell you whether you did the right thing.
Quebec scenario
A borrower in Gatineau holds a 5.9% fixed rate for another 26 months and sees offers at 4.6%. His bank calculates the penalty using the interest rate differential: $6,400, payable on the payout date. At the new rate the interest savings come to about $250 a month, but he has to subtract the penalty and the notary and appraisal fees. Break-even lands around month twenty-four. If he sells or renews before then, breaking costs more than it saves. Before deciding, he uses his 15% prepayment privilege to shrink the balance, which lowers the penalty itself. Since he plans to keep the house at least five years, he breaks the mortgage and documents every figure in his calculation.
Checklist
- Request the exact penalty amount in writing
- Verify the applicable formula, three months or differential
- Use the prepayment privilege before breaking
- Price the interest savings at the new rate
- Add notary, appraisal and exit fees
- Calculate the break-even point in months
- Compare it with how long the loan will really be kept
- Redo the math if rates move before signing
- Document every figure in the decision file
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