There is a lot of money at stake in mortgages for both lenders and borrowers. With soaring home prices, even low-interest rates can generate thousands of dollars in interest over the length of the mortgage term and even more over the amortization period. Because of this, mortgages have evolved into complicated legal arrangements with a long list of terms and conditions meant to protect the lender's investment.
The Evolution of Mortgages
Mortgages (as we know them) have been around since the early 1900s. At that time, mortgage loans were more likely to be held by the property seller or mortgage investors than by a bank or financial institution. As the financial hardships of the Great Depression and war changed the markets, mortgages changed as well. Banks began to offer long-term, fully amortized mortgages to help make homes more affordable and insulate homeowners from volatility in the economy. So, as long as you could continue to make payments, you could live in your home for the 25 to 30 years it would take to pay it off.
Homeowners Demand More
In the 1970s, high inflation caused interest rates to fall. Homeowners were stuck with long-term mortgage agreements at interest rates that no longer made sense. That's when the mortgages we are most familiar with today, so-called partially amortized mortgages, began to appear.
Partially amortized mortgages have shorter terms of 3, 5 or 10 years though the principal repayment is calculated at the fully amortized period. These types of mortgages protect lenders and borrowers from fluctuations in the market. Even better, they give borrowers the flexibility to take advantage of lower interest rates or change their mortgage terms when they no longer meet their needs. Lenders began building in safeguards, including fees and penalties for breaking mortgages early, to avoid the risk of potentially losing interest income.
Reasons You May Want to Leave Your Mortgage
There are many reasons why your mortgage may no longer suit your situation. For example, at the beginning of the pandemic, interest rates fell several times, to almost all-time lows. Plenty of people were affected financially by the pandemic through job losses or reductions in income, making it difficult to manage their mortgage payments. Others who hadn't planned on moving found themselves looking to get out of the city in a hurry. In any of these situations or many others not related to the pandemic, it may be worthwhile to break your mortgage so you can get a new one with better terms. Before you make any final decisions, you need to look closely at your current mortgage contract.
Calculating Penalties
The terms and conditions of your contract will include a clause outlining the fees and penalties that can be levied if you choose to break the contract early. The amount differs depending on the lender, the length of time left in the term, and other factors. Often the calculation of three or more months of interest is used. An interest rate differential (IRD) may be used if you stick with the same lender and the interest rate of the new mortgage is lower. In this case, the total remaining interest for the term is calculated at the current rate and the new rate. You then pay the difference as a penalty for breaking the contract. Some mortgages have prepayment fees that penalize you for repaying the mortgage before the end of the term. These penalties can add up, so it is important to do the math to determine if breaking the mortgage is worthwhile.
Now calculate what you'll be saving by entering into a new mortgage contract with the same or a different lender. If the interest rate is much lower, or the repayment terms are more forgiving, it may work out in your favour. However, if the cost of getting out of your current mortgage is more than you'll save, you may consider staying put.
Don't forget, whatever your situation, a mortgage broker can help you find options to suit you. Whether you are thinking of moving up, downsizing, or need help with managing your current mortgage, your mortgage broker is here to help with the knowledge and expertise to get you on track.