The Costs of Breaking Your Mortgage Contract

The costs of breaking your mortgage contract when selling your home largely depend on the type of mortgage you have. If you're unsure of whether you have a closed or open mortgage, now is the time to review your contract and understand its terms.

Open Mortgages

If you have an open mortgage, you're in luck. Open mortgages allow you the flexibility to sell your home or pay off your mortgage early without incurring penalties. These mortgages are designed for homeowners who may want to make additional payments or sell their home before the mortgage term ends. While open mortgages don’t charge penalties for breaking the contract, they come with higher interest rates compared to closed mortgages, as lenders offer more flexibility.

This option is typically ideal if you anticipate paying off your mortgage early, making larger payments, or needing the flexibility to sell before the end of your term.

Closed Mortgages

In contrast, closed mortgages offer a lower interest rate but come with much less flexibility. If you choose to sell your home or pay off your mortgage early before the end of the term, you will likely face penalty fees. These penalties are meant to deter borrowers from making changes to their mortgage agreement before the term is up.

With a closed mortgage, your lender may allow some limited prepayments—such as paying a certain percentage of the principal each year—but anything beyond that (like paying off the mortgage or breaking the contract early) will incur a penalty. The penalties for breaking a closed mortgage can include prepayment penalties, administrative fees, appraisal fees, and even a mortgage discharge fee to remove the charge from your current mortgage.

In addition, if you received any cash-back or a home equity line of credit when you took out your mortgage, you might have to repay that as well. These additional fees can make breaking a closed mortgage quite costly.

Options for Breaking a Mortgage Contract

If you’re considering selling your house with a mortgage, there are a few options to explore:

• Blend-and-Extend: Some mortgage lenders may offer the option to blend your old mortgage rate with your new mortgage rate in a process called "Blend-and-Extend." In this case, your new rate is a combination of your current rate and the rate for your new term, which could help reduce the prepayment penalty. However, this option is not available with every lender and may still involve some administrative fees.

• Breaking the Mortgage: If the Blend-and-Extend option isn’t available, you’ll likely need to break your mortgage contract. This will result in paying a prepayment penalty, but you may also secure a lower interest rate for your new home, which could help offset the cost over time.

Before deciding whether to break your mortgage, it's important to weigh the costs of the penalties against the benefits of a new mortgage rate or new home.

Pros and Cons of Selling a Home with a Mortgage

While selling your home with a mortgage can bring about positive changes, it's also important to be aware of the potential drawbacks.

Pros:

• Lower Interest Rates: If interest rates have dropped since you took out your mortgage, selling your home could allow you to secure a better rate on a new property, potentially saving you money over time.
• Pay Off Your Mortgage Sooner: If you can maintain similar monthly payments on your new mortgage, you might be able to pay off your mortgage early and reduce the amount of interest you pay overall.

Cons:

• High Penalties: Breaking a closed mortgage can come with significant penalties that could add up quickly. These penalties might end up outweighing the benefits of moving to a new home or getting a lower rate.
• Qualification Uncertainty: Depending on your current financial situation and the market conditions, you may no longer qualify for a mortgage under current lending rules or interest rates. This could make your decision to sell more complicated if you’re planning to buy a new home.

Mortgage-Breaking Penalties

Mortgage-breaking penalties can be quite steep, particularly for homeowners with a fixed-rate closed mortgage. The penalty is usually calculated using one of two methods: Three Months’ Interest or Interest Rate Differential (IRD), whichever results in the higher fee.

• Three Months’ Interest: This penalty involves paying the interest on your mortgage for three months. For example, if you owe $300,000 on your mortgage and your interest rate is 6.59%, the penalty would be roughly $4,942.50 (calculated as $300,000 x 6.59% ÷ 12 x 3).

• Interest Rate Differential (IRD): This penalty is calculated based on the difference between your current mortgage rate and the rate that is available for a similar term today. For example, if your current rate is 6.59% but current rates are 4.74%, the difference is 1.85%. Applying this difference to your remaining mortgage balance, you might owe an IRD penalty of approximately $11,100.

In this case, the penalty of $11,100 would be the higher amount and the one you’d need to pay to break your mortgage.

While breaking your mortgage early can feel costly, you might be able to reduce these fees by utilizing any prepayment privileges available to you.

When Do You Stop Paying Your Mortgage?

Once you sell your home, part of the proceeds from the sale will go toward paying off any remaining mortgage balance, as well as any penalties or fees associated with breaking the contract. You will no longer need to make monthly mortgage payments once the mortgage is fully paid off.

If you've already paid off your mortgage before selling, your mortgage payments will stop immediately after paying off any associated fees.

Additional Considerations

• Investment Properties: If you’re selling an investment property or a secondary home, be aware that you may face capital gains tax in addition to the mortgage-breaking penalties. This tax applies to 50% of the profit you make from selling the property, which could impact the overall financial outcome of selling your home.

• Request a Payoff Quote: Before moving forward with selling your home, contact your mortgage lender to request a payoff quote, which outlines the exact amount remaining on your mortgage, including any penalties and fees.

• Calculate Home Equity: Consider how much equity you have in your home. If your property has appreciated significantly since you bought it, even high penalties might be justifiable if you have enough equity to cover them.

Conclusion

Selling a home with a mortgage can be a complex process, but with the right information, you can navigate it smoothly. Before making any decisions, it’s essential to fully understand the costs associated with breaking your mortgage contract and how they align with your financial goals. I’m here to help guide you through this process and ensure you make an informed decision. Reach out to me, Diane Walker, if you need expert advice and support as you navigate selling your home with a mortgage.