On average most people break their 5 year fixed mortgage term 3.5 to 4 years down the road.
When considering your options, whether it's for a new mortgage, or if considering breaking your existing mortgage term for any reason there are some important things you should know.
Many financial institutions or mortgage lenders charge a prepayment amount or penalty in order to recoup any losses for breaking that contract. There are different ways to calculate these prepayment costs and different scenarios they would be applicable in.
With many lenders the calculation is for 3 months interest or the Interest Rate Differential and most of the time it is whichever is GREATER. The Interest Rate Differential or IRD is applicable, with most banks, when breaking a contract for a fixed mortgage term. This is one component to consider when making the age old decision of going fixed or variable. The reason why is because if you break a Variable rate mortgage term only the 3 months interest would be applicable with most lending institutions. That's not to say that the IRD is always greater than 3 month interest penalty but over the last few years as interest rates have drastically fallen this has been the case.
Most of the time a fixed or variable closed mortgage term would be a good option as you will get the better rate. With that being said you should always confirm verbally and then in your mortgage agreement that you can port your term & rate to a new property should you decide to sell & buy before the contract has expired. The average time frame to take advantage of a portability option is 90 days between sale and purchase.
But if you know you're coming into a inheritance or you're going to be in a position to pay down more than the allowable prepayment options most lenders allow then an Open mortgage term or a Home Equity Line of Credit may be a better option.
Some numbers that go into an Interest Rate Differential Calculation are:
1.Your current contract's interest rate
2.The posted rate at origination
3.The months left in the mortgage term
4.The relevant market or comparison rate (Example: If you're 3 years into a 5 year mortgage term your existing 5 year rate would be compared to a current 2 year rate as this is the remaining time left in your term.
5.The current mortgage balance
Some of these numbers may be easy to confirm while other you will need to contact your lender.
RBC has a solution with its penalty calculator that you could consider using if your curious to get an estimate of what charges you may be looking at. And if it makes sense to break your mortgage term.
If you have any questions or would like to discuss further please feel free to contact me at anytime.
Tony Marchigiano | Mortgage Specialist - Mortgage Sales BC Region, RBC Royal Bank | Royal Bank of Canada | T. 604-505-7109 | F. 778-737-0054