Like the look of a lower mortgage rate? Avoid the penalty to break your current mortgage and get a “blended rate”
Given the current low rate environment, many people are inquiring about how to lower their current mortgage costs. If you’re one of the many that took a fixed rate back in 2008 or 2009, you are likely in the range of 4 to 5% or even higher and you’re stuck with it for one or two more years. This is frustrating when current rates are being offered as low as 3.29% for a new 5-year fixed term.
Typically, the mortgage penalties you incur to break your mortgage are set up as the greater of three months interest or Interest Rate Differential (essentially, the difference between your mortgage rate and the current rate your bank is offering for the same term you have remaining). This is in place to avoid people constantly breaking existing mortgages to go to a better rate and this IRD penalty will typically negate any savings from doing so. However, there is what I like to call a “sweet spot”, where your rate is not high enough to trigger IRD and only three months interest penalty applies. At the time I am writing this, I find that rate to be around 3.89%.
However, most people do not fit this scenario and if their rate is over 4%, they are likely subject to the IRD penalty and breaking the term does not make sense. So what do you do? Speak with your mortgage planner about a Blended Mortgage. There are two options that most banks will offer: Blend and Extend or Blend to Term. Under a Blend and Extend option, the bank will give you a brand new term at the current rate but ‘blend’ in your penalty to your new rate so you are not required to pay it out of your pocket or add it to the mortgage.
For example, if your current rate is around 5% with approximately 2 years left and your bank is offering a current 5-year fixed rate of 3.29%, you’d end up with a new 5 year term at a rate somewhere in between. While you may not be getting the absolute lowest rate, this is far better than paying the 5% you had left for two years and you avoided paying a penalty or increasing your mortgage balance. Plus, you entered into a new contract and now have an additional three years protection over your current term.
The Blend to Term option is the same idea but your term remains as is. For example, you would end up with the same two years left but at a lower rate (in between your existing rate and the rate currently being offered for a two year term) and again, no penalty out of your pocket or added to your mortgage. Why would one want to go this route versus blend and extend? If you plan to sell your property, this is a good option as it gives you an out after only two years versus five. This flexibility could be beneficial as you could avoid paying penalties to sell early. Some banks only offer the Blend to Term solution. It is important to know your prepayment options before choosing a lender/rate because flexibility is just as important and sometimes more important than getting the lowest rate.
Bottom line, talk with a mortgage planner and find out your options. If you’re in that “sweet spot” a good planner will show you calculations on just how much you can save by breaking your mortgage. If you’re subject to an IRD, a good planner will go over what blended options are available to you and take into account your time frame and overall goal to help you select the option that’s the best fit.
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*These numbers are approximate and for illustration purposes only. Rates are subject to change without notice.