Top tips before you switch your mortgage (hint: avoid expensive fees)

Key factors to consider before switching your mortgage in Canada

Switching your mortgage isn’t as easy as calling your broker and saying, “Hey, I think I’d like to try something new.” It’s not as simple as changing your clothes. There are a few things you’ll want to keep in mind.

Understand your mortgage contract

A mortgage is a binding contract you signed at the beginning of your term. You’re contractually obliged to uphold your end of the deal, namely paying your regular agreed-upon mortgage payments, which are based on your mortgage size, amortization period, term length and interest rate. However, you can switch your mortgage if you’ve found another one that makes more sense for your current situation.

Before doing that, read your current contract carefully. It will outline whether your mortgage is open or closed, which will help determine how much it will cost to break your mortgage. If yours is open, you’ll likely be able to break it without paying any fees. If, however, your mortgage is like most Canadian mortgages, it’s closed, and there will be fees associated with breaking your contract.

Assess interest rates

A big reason to switch mortgages is to get a better interest rate. Do your research to see what’s available, and speak to a broker to determine if you qualify for a low rate. After all, you likely want to switch your mortgage for a higher rate.

Use a mortgage calculator to crunch some numbers and determine how your monthly payments will be affected if you switch your rate and consider how much mortgage you can afford. Once you calculate the penalties you can expect to pay for breaking your mortgage, this will help you determine if the switch is worth it. This brings us to our next point.

Evaluate prepayment options and penalties

Before making the switch, consider the new mortgage terms. If you think you’d like to make additional mortgage payments in addition to your regular ones (these are prepayments and help you pay your mortgage off sooner), look to see what sort of prepayment privileges your potential new mortgage offers. Typically, mortgages allow for a specific amount of prepayments per year.

You’ll also want to take a close look at penalties. Not all mortgages are as open and relaxed as others. Depending on the lender, there might be penalties for late payments and penalties for breaking your mortgage (which your current mortgage might also have, and it leads us to our next point).

Consider the cost of breaking your mortgage

Before breaking your current mortgage and making the switch, it’s essential to understand if it makes financial sense. Assuming you qualify for a lower rate, you may save money on payments with your new mortgage, but you’ll likely have to pay a penalty for breaking your current mortgage.

Your lender can help guide you through the process, but penalties work differently depending on whether you have a fixed or variable interest rate.

The penalty for breaking a fixed-rate mortgage is usually calculated using an interest rate differential (IRD). Lenders may have its own way of calculating this, but the lender figures out how much interest it will lose if it were to lend the same amount as your mortgage at current rates compared to the rate you were given. This can sometimes amount to a few thousand dollars, assuming rates are lower today than when you signed your mortgage.

Sound intimidating? Don’t worry; there are online prepayment calculators that can help you get a sense of what breaking your mortgage might cost.

The penalty for breaking a variable-rate mortgage is much more straightforward. The lender will charge you the cost of three months' worth of interest on your current mortgage principal.

When you know how much you can expect to pay in penalties, you can weigh that against the amount you can save from signing a new mortgage. That will help you determine whether or not it’s worth breaking your mortgage.

Consider other potential costs, such as discharge fees. Your lender will outline these for you, and you can ask your broker to help explain them.

How much home can you afford?

Whether you're hunting for a new home or looking to refinance your mortgage, knowing how much your new loan might cost you is critical. Use our handy mortgage calculator to help you understand what your payments could look like.

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Switching mortgage lenders

Before switching to a new mortgage lender, you should do some research. Do they have a solid reputation? Are there reviews you can read online?

If you’ve found a new lender to switch your mortgage to, carefully read the terms and conditions of the mortgage contract you’ve been sent. Not all mortgage lenders operate the same, so it’s important to note what’s laid out in the agreement, including:

• The mortgage interest rate
• The mortgage term you agree to pay the rate for
• Prepayment privileges (how much extra you can pay toward your principal, above your regular payments)
• The payment frequency
• Any potential fees and penalties (such as an early exit penalty, service fees, administration fees, discharge fees and late payment fees)

Make sure the payment terms are favourable and manageable before making the switch as well.

If you’d like some guidance during the process, it’s a great idea to work with a mortgage specialist or broker. They have access to several lenders and will shop around for you to help find the best mortgage. Since they’re compensated by the lender, they’re also completely free to use, so they’re a great resource to help you save money and find the best loan.

Impact on monthly payments and interest rates

Getting a better interest rate is a great reason to break your mortgage and switch lenders before the end of your term. Before making the switch, though, you’ll want to figure out how much you’re set to save. This will help you decide if it’s worth incurring penalties to get out of your original contract.

Calculate potential savings and subtract fees to determine whether the switch is worth it. We’ll use an example, but you can crunch the numbers yourself based on your situation. And if you’re not super number-savvy (don’t worry — you’re not alone!), your broker can help you.

First, let’s get started with an example. Let’s assume you have a five-year fixed rate of 4% on a $300,000 mortgage, amortized over 25 years. We’ll also assume you have three years left on your term and that you’ve qualified for a new rate of 3.5% with a different lender.In this example, your remaining mortgage principal is about $285,000. Your interest cost over the next three years would be $32,547.63. Now, with a 3.5% rate, you’d pay $28,434.86 over the next three years. That’s a savings of $4,112.77 in interest over three years.

Using the prepayment calculator, we can find out that the penalty to break that mortgage would be nearly $13,000. In this case, you’d be paying more in penalties than you’d save on interest, so in most cases, this switch wouldn’t be worth it.

This is just one example. You’ll need to do a little math using your situation to determine whether or not the switch is worth it. Compare mortgage rates to determine whether you might get a lower rate. Then, please speak to your lender to determine how much breaking your mortgage will cost. Finally, calculate how much you might save by making the switch — or have a broker guide you through that process.

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How to switch your mortgage in Canada

1. Do you research: Before you break your mortgage, find out what fees you can expect to pay. These include prepayment penalties, administration fees, appraisal fees, reinvestment fees and mortgage discharge fees.

2. Talk to your existing mortgage lender: Speak with your lender to make sure you can break your mortgage. Discuss the fees and make sure you understand the total amount you’ll owe.

3. Gather your information: You’ll then want to gather all the necessary documents, like proof of ownership (like a property tax bill works), income qualification (pay stub or employer letter) and proof of property insurance.

4. Talk to your new lender: Speak with the new lender you plan to use and ask them what else might be required — a broker or agent can also help you with this.

Conclusion

Switching your mortgage before the end of your contracted term isn’t always a good idea. It could end up costing you more in penalties than you would save with a lower interest rate.

It’s essential to assess your current situation, speak to a broker to help you decide whether it’s worth it, and follow the proper steps to ensure the switch is in your best interest — no pun intended.

Switching mortgages FAQ

Can I switch from variable to fixed mortgage?

Yes, you can lock in your fixed-rate mortgage at any time, however, once you switch to a fixed-rate mortgage, your mortgage will remain fixed for the remainder of the term of the existing contract.

Can you switch mortgage lenders in Canada?

Yes, you can move to another lender when your contract expires if you prefer their rates and terms. You can switch lenders mid-contract, but there can be a penalty associated with breaking your contract early.

Is there a penalty for switching mortgage lenders in Canada?

It depends. There is no penalty for switching mortgage lenders if your existing mortgage contract has expired, but there can be a penalty if you break an existing contract. Make sure you fully understand the terms of both contracts before switching mortgage lenders.

— with files from Leslie Kennedy