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Reason #4 to Refinance: Saving on Interest

Did you sign up for a fixed-rate mortgage when rates were higher? I’m sure you thought you were getting a pretty good deal when you signed up. Then COVID-19 happened, and mortgage rates plunged to levels we never thought we’d see.

In this week’s blog post, we’ll look at the fourth reason to refinance: to save on interest.

Save Interest

How Do Fixed Mortgages Work?

Canadians love fixed mortgages. Fixed mortgages are a lot more popular than variable rates. Canadians can’t seem to get enough of the five-year fixed rate. With a five-year fixed rate, you can “set it and forget it.” Your mortgage rate and payment stay the same for five years. This provides you with peace of mind and stability. However, fixed-rate mortgages aren’t without their risks.

When you sign up for a fixed-rate mortgage, you’re beating that mortgage rates will remain flat or head higher in the future. However, if the opposite happens and fixed mortgage rates head lower in the future, there’s an opportunity cost to your fixed mortgage. That’s when you might consider breaking your fixed-rate mortgage.

Why Break Your Fixed Rate Mortgage?

A reason you might break your fixed-rate mortgage is to lower your monthly mortgage payment. However, a far more common reason to break your fixed-rate mortgage is to save on interest.

Think about it this way: you could stay in your current mortgage at a higher fixed rate than is available, or you could break your mortgage and sign up for a fixed mortgage at a lower mortgage rate. It may seem like a no-brainer; however, breaking your fixed-rate mortgage isn’t without its costs, mainly the mortgage penalty.

What is the Mortgage Penalty, and How Does it Work?

The formula for calculating a fixed-rate mortgage penalty is the greater of three months of interest or something called the Interest Rate Differential (IRD). The IRD is a fancy way of saying how much interest your lender is losing when you break your mortgage.

The banks tend to have the highest penalties since the posted rate is used to calculate your penalties, whereas monoline lenders tend to have more reasonable penalties.

If you’re considering breaking your fixed mortgage, you’ll want to contact your lender to find out what your penalty would be for breaking. It’s best to email rather than phone to get the penalty in writing.

Doing the Cost-Benefit Analysis

If you’re breaking your mortgage just for interest savings, you’ll want to do a cost-benefit analysis to see if it would be worthwhile.

The cost-benefit analysis looks at potential interest savings from breaking your mortgage and signing up for a mortgage at a lower rate. It also looks at the cost of refinancing (mainly the penalty and any other fees).

The Bottom Line

Not sure whether breaking your mortgage is worthwhile to save on interest? Reach out to one of our mortgage experts to run the cost-benefit analysis for you to see if it would make sense.

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