When do I pay a penalty?
Most mortgage terms are “Closed”. And if you have to pay them off early or “break out” of them, there is a penalty.
Open mortgages exist too and are usually in the form of a secured line of credit or private mortgage. With open mortgages, you can pay it off in full at any time.
Closed mortgages, however, cannot be completely paid off in full at any time. If you do need to pay off the mortgage in the middle of your mortgage term you will need to pay a penalty.
How much is the penalty?
The penalty cost will vary depending on the mortgage product you are in. Each lender seems to have their own way of calculating penalties. Some banks are notorious for having especially high penalties. If you want to find out the penalty for your current mortgage, the best way is to call your lender and ask.
Variable rate mortgages often have only a 3 months of interest penalty. This is ideal, and another reason variable rate mortgages are a good choice if you can qualify for it.
Some Variable rate and fixed-rate mortgages, however, often called “Low rate Basic” mortgages, can have a mortgage penalty significantly higher. For example: 3% of the mortgage balance as a penalty is not uncommon for these low rate basic products. In most cases, you’ll want to avoid mortgages with these types of penalties because most people do end up breaking their mortgage before their term is complete.
What else do I need to know?
Breaking out of your mortgage most often happens when you decide you want to move to a new home. Many mortgages can be ported, however, depending on the rates when you decide to move, it might end up being financially best to just pay the penalty and get a new mortgage. When we work with clients that are selling and buying we will run a comparison and show you the two options and determine which one saves more money.
Although paying your closed mortgage out early will result in a penalty, you can still make extra payments towards your mortgage to pay it down faster.