Is It Cheaper to Break a Variable-Rate Mortgage

The decision to break a variable-rate mortgage is one that many homeowners face, especially when interest rates fluctuate. With the potential for significant savings, it's essential to consider whether breaking your mortgage could be a financially savvy move. However, the answer isn't always straightforward, as various factors can influence the overall cost and potential benefits. In this article, we'll explore the key considerations when deciding if breaking a variable-rate mortgage is the right choice for you, and how to navigate the complexities of this financial decision.

Understanding the Costs of Breaking a Variable-Rate Mortgage

Breaking a variable-rate mortgage can be a complex decision that depends on various factors. It's essential to understand the potential costs involved before making a decision.

The Prepayment Penalty

One of the most significant costs associated with breaking a variable-rate mortgage is the prepayment penalty. This is a fee charged by lenders when you pay off your mortgage before the end of your term. The penalty is typically three months' interest on your current balance, but it can vary depending on your lender and specific mortgage terms.

The Interest Rate Differential (IRD)

The Interest Rate Differential (IRD) is another potential cost when breaking a variable-rate mortgage. This is the difference between your current mortgage rate and the rate the lender could get if they lent the money out again. If rates have dropped since you got your mortgage, this could be a significant cost.

Other Fees and Charges

In addition to the prepayment penalty and IRD, there may be other fees and charges when breaking a variable-rate mortgage. These can include discharge fees, administrative fees, and legal fees. It's essential to check with your lender to understand all the potential costs involved.

Comparing the Costs

To determine if breaking your variable-rate mortgage is cheaper, you need to compare the costs of breaking your mortgage with the potential savings from switching to a new mortgage with a lower interest rate. This requires careful calculation and consideration of all the potential costs and benefits.

The Role of Professional Advice

Given the complexity of the decision, it may be beneficial to seek professional advice. A financial advisor or mortgage broker can help you understand the costs and benefits of breaking your mortgage and whether it's the right decision for your financial situation.

FAQ

What is a variable-rate mortgage and how does it work?

A variable-rate mortgage, also known as an adjustable-rate mortgage or floating rate mortgage, is a type of home loan where the interest rate charged on the outstanding balance fluctuates over time. This fluctuation is typically based on a benchmark like the prime rate or federal funds rate, plus or minus a margin. The rate can change at predetermined intervals, such as every month, quarter, or year. This type of mortgage can be attractive because the initial rates are often lower than fixed-rate mortgages. However, they also come with the risk of increased payments if interest rates rise.

Is it cheaper to break a variable-rate mortgage compared to a fixed-rate mortgage?

Breaking a variable-rate mortgage can often be more cost-effective than breaking a fixed-rate mortgage due to the way prepayment penalties are calculated. In general, the penalty for breaking a variable-rate mortgage is typically three months' interest. In contrast, the penalty for breaking a fixed-rate mortgage is usually the greater of three months' interest or the interest rate differential (IRD), which can be substantially more, particularly if interest rates have fallen since you took out your mortgage. However, the actual cost can vary depending on your lender's specific terms and the time remaining on your mortgage term.

What factors should I consider before breaking a variable-rate mortgage?

Before deciding to break a variable-rate mortgage, you should consider several factors. These include the current interest rate environment - if rates are falling, it might be beneficial to break your mortgage and lock in a lower rate. Conversely, if rates are rising, it might be better to stick with your current mortgage. You should also consider the prepayment penalty - is the cost of breaking your mortgage worth the potential savings? Additionally, consider your financial stability and long-term plans. If you're planning to sell your home soon or expect a significant increase in your income, breaking your mortgage might make sense.

Are there any alternatives to breaking a variable-rate mortgage?

If you're considering breaking your variable-rate mortgage due to concerns about rising interest rates, there are alternatives. You could consider a blend and extend option, where you blend your current rate with a new rate for a longer term, providing a fixed rate that may be lower than what you'd get if you broke your mortgage. Alternatively, if you have a good amount of equity in your home, you could consider refinancing. This would allow you to take advantage of lower rates without having to break your current mortgage. However, this also comes with its own set of costs and considerations, so it's best to consult with a financial advisor to determine the best course of action for your individual circumstances.