With rates these days at historical lows, you may be wondering if it is the right time to break your current mortgage and lock into a new term to take advantage of these low interest rates.
However, remember that if you have a closed mortgage, you will incur what is called a pre-payment charge.
Why you ask?
Well, most of today's mortgages are 'closed' terms. A closed term offers you a lower rate for the same length of time that an open mortgage does.
With an open mortgage you can pay off any amount at any time without penalty. A closed mortgage offers a lower rate because the pre-payment privileges, or the amount you can pre-pay your mortgage above your normal regular payment amount, is restricted (to usually 10% of the original principle amount).
This pre-payment comes into play when you want to renegotiate or break your existing mortgage for any reason, including if you wish to acquire a new rate. Your mortgage is a contract with the bank that states you will pay a certain amount each month back to the bank for a certain period of time.
Now, in order to lend you the money at this 'fixed rate' for a set period of time, RBC Royal Bank® borrows the funds needed in the market and enters into fixed term contracts. When you break your mortgage term (or contract), RBC Royal Bank is in turn charged a 'breakage cost' as it's contract will not be fulfilled. The mortgage pre-payment charges are collected from you to partially offset the costs that the bank is charged because you are no longer paying that agreed upon amount back to us on a monthly basis.
To learn more about how the prepayment charge is calculated, click here, give us a call or even look at your original mortgage documents that you signed.
But the rate is so much lower now, it must be worth it?
Well, that is hard to say. It really does depend on a number of factors - such as your current interest rate, the length of time left on your mortgage term and your mortgage balance. Once you take into consideration the prepayment charge, you may not come out ahead at all.
The other item to keep in mind is no one has a crystal ball on where interest rates will be when your existing term would have expired. This has an impact on whether or not you come out ahead in breaking your current mortgage. If rates are even lower than today, you will be forgoing that lower rate. For example, if you are 3 years into your 5 year term now, and you chose another 5 year term, you could be forgoing an additional 2 years of lower rates that you would have received if you did not break your mortgage today. Of course, no one can predict the future direction of rates.
Everyone's situation is unique, so to give any rules of thumb is difficult, but generally, it is never a good idea to break your mortgage if you are early in your term (for example only one year in to a 5 year term).
Another recommendation to save you money on your mortgage is take the money that you would have used to pay the pre-payment charge and apply it as a principal payment against your mortgage. This will have a significant result to your overall mortgage costs.