Is it worth breaking a mortgage and paying the penalty?

When selling or refinancing you must take into account the penalty being charged by the banks. Many lenders will charge either a three months penalty or interest differential (IRD) depending which is higher.  

The three months penalty is easy to calculate in that you take the outstanding balance of your mortgage, for example $200,000 times your current interest rate 5.25%, divided by twelve, times three, which will equal $2,625.00. However to calculate IRD you need to figure out how long a term you have left, say 3 yrs and compare it to the rate offered by your institution for a 3yr mortgage say 3.75%. The difference is 1.5% times three, the remaining years left which translate to 4.5%- your penalty is 4.5% of the outstanding balance or $9,000.00.  

As you can see there is quite a difference and when you call the banks they often quote the three months penalty. However, when it comes time to order the discharge statement at the lawyer's office that is when you find out what the real penalty is.  

There are ways of reducing this penalty but the best way is to make a prepayment if you can and most lenders will allow a 15 - 20% prepayment before breaking the mortgage. This is, of course, assuming that you have access to the money to make the prepayment.  

There are times that it may be worthwhile to pay the IRD even though it is higher than three months penalty. Today interest rates are at the lowest level in modern history with some of our lenders offering rates as low as 3.54% for good credit clients on a 5yr term.  If you feel that in three years interest rates will be higher than today's, then you may be better off breaking the mortgage paying the penalty to guarantee that you will have a further  two years at the lower interest rate (the three years until your mortgage comes due plus an additional two years totaling five years).  This is like hedging your bet verses doing nothing and waiting till your mortgage comes due hoping that interest rates don't rise.  In the worst case scenario rates remain the same as today and  you are no further ahead.  

However, if I am a betting man, I would bet that in three years time interest rates will be much higher!

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