Breaking a Mortgage Contract

By Cindy Janisch

Breaking a Mortgage Contract

If you must break the term and payout your mortgage earlier than you agreed to on your Mortgage Contract you will be subject to a payout penalty.

Breaking the Mortgage Agreement

Read your mortgage contract or contact your lender to find out if you can break the contract. Different lenders have different terms and conditions. When a contract is broken a penalty and fees are charged.

Before breaking your mortgage agreement, find out whether:

• You have to pay a penalty and what that amount is.
• If you have to pay an administration fee.
• If you have to pay legal or disbursement fees to discharge the old mortgage.
• If you have to pay legal or disbursement fees to register the new mortgage.
• If you have to repay some or all of any ‘cash back’ you may have received when you first obtained the mortgage.
• And if the calculation of any prepayment penalty would be based on the posted rate at the time you signed the agreement, or on a discounted rate if you negotiated one for the initial mortgage.

Securitization

For you to understand why you must pay a penalty to your current lender if you break your mortgage contract you must understand where the money for your mortgage came from.  This is called Securitization and it is a process by which certain financial assets are pooled together so that they can be packaged into interest bearing bonds.

If you have a mortgage with a Bank or Mono line lender, then you have a Mortgage that is either held in these two types of Bonds.  Mortgage Backed Securities (MBS) or Canada Mortgage Bond (CMB).  These two vehicles are how the banks get the cash that they need to lend to you the consumer so that you can purchase your home.

Mortgage Backed Securities return monthly payments to the initial investor that put up their capital so that you can borrow it to Mortgage your house. With your mortgage contract, you have agreed to an interest rate and term that you will continue to pay this initial investor.

Similar the Canada Mortgage Bond is a “bullet bond” designed to get the investor a fixed amount of interest paid at the end of the term.  This product is popular with foreign investors and pension portfolio’s.

At the end of the day the bank or lender that you have your mortgage with will pool and bundled their mortgages and sell them on the bond market to investors.  You must payout your penalty because the banks must provide the interest promised to the initial investor.

Different Lenders Calculate Penalties Differently!

Different lenders calculate their penalties differently because they are Securitizing their mortgage pools and selling them to different MBS and CMB investors. Most of the Big Banks base the penalty on the posted rate at the time when you signed your mortgage INSTEAD of your actual rate.  This has a large impact on your penalty cost.

Speak with Cindy Janisch about Interest Rate Differential calculations and how you can save yourself money should you break the Mortgage Contract before term.

What is Interest Rate Differential?

The IRD is a compensation charge that may apply if you pay off your mortgage prior to the maturity date, or pay the mortgage principal down beyond the amount of your prepayment privileges.

The IRD is based on:

• The amount you are pre-paying; and,
• An interest rate that equals the difference between your original mortgage interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of the mortgage.

Most closed fixed-rate mortgages have a prepayment penalty that is the higher of 3-months interest or the IRD. Most variable-rate mortgages do not have IRD penalties.

A common misconception about mortgages are the flashy low rate that some lenders can advertise and offer.  But, would you truly be worried about paying a .10% higher for a mortgage that securitize their bonds differently and have better policy around their IRD calculations.

A good conversation with your Mortgage Professional will determine which product is right for your current situation.